Foreign Aid Inflows and the Real Exchange Rate: Are There Dutch Disease Effects in Ghana?

This paper presents empirical evidence that the massive foreign aid inflows into Ghana that accompanied the 1983 reforms had some Dutch disease effects. This finding contrasts with some of the startling findings in the recent literature that aid inflows into Ghana, instead of causing real appreciation of the cedi, caused its depreciation. Using the behavioral equilibrium real exchange rate approach, it is found that foreign aid inflows do have a significantly positive effect on the real exchange rate in the long run, but not in the short run. It is argued that this is plausible when aid increases are saved to raise foreign reserves as was the case in Ghana. In the long run, however, when all aid increases were spent, real appreciation could be expected as the theory predicts. The policy implication of this finding is that Ghanaian authorities must ensure that aid increases are spent on raising Ghana's productive capacity so that supply response will offset any negative effect of the real appreciation on economic growth.