We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption-an increase in the current account deficit net of aid-delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption and result in large accumulation of reserves-are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.
Berg, A., Portillo, R., & Zanna, L. F. (2015). Policy responses to aid surges in countries with limited international capital mobility: The role of the exchange rate regime. World Development, 69, 116–129. https://doi.org/10.1016/j.worlddev.2013.12.017