THE TRANSFER PROBLEM REVISITED: HAVE WE FORGOTTEN THE MONETARY ASPECT?

Selim Elekdag
The Johns Hopkins University

This paper analyzes the famous "transfer problem" in a two country dynamic stochastic general equilibrium framework. Transfer effects include the impact of foreign aid, debt relief and huge current account reversals. More precisely, it considers the repercussions of transfers under fixed and floating exchange rate regimes. The adage that the nominal exchange rate is a shock absorber and hence the superiority of flexible exchange rate regimes can not be unambiguously accepted. This is especially the case when more realistic calibration is considered in the form of asymmetric country size. More specifically, I analyze the impact of foreign aid from a larger economy to a smaller economy under various exchange rate regimes.