Macroeconomic effects of foreign aid and remittances: Implications for aid effectiveness studies

In this paper we quantify the impact of wealth transfers such as remittances and foreign aid using a DSGE-RBC model. We calibrate and simulate the model using data from 85 recipient countries. We show that positive wealth transfer shocks have a lagged positive response on output provided that persistence is sufficiently low, but these effects are small in comparison to other aggregate shocks. In fact, our calibration and simulation results suggest that wealth transfer shocks would need to be around nine times as large in order to produce the GDP volatility created by productivity shocks. The policy implications of our work primarily consist in providing guidance for research that tries to empirically estimate the aid-growth relationship.