The Fiscal Effects of Aid in Ethiopia: Evidence from CVAR Applications

Abstract

This article explores the fiscal effects of aid in Ethiopia using the Cointegrated Vector Auto-Regressive (CVAR) methodology to model complex long-run and short-run dynamics. We use national data for 1961–2010, including a measure of aid capturing flows through the budget as measured by the recipient. The data suggests three main conclusions on the long-run equilibrium. First, government long-term spending plans are based on domestic sources, treating aid as an additional source of revenue. Second, both grants and loans are positively related to tax revenue. Third, aid is positively associated with spending, with a particularly strong relation between capital expenditure and grants. Overall, our results show that aid in Ethiopia had beneficial fiscal effects.