Abstract:

Foreign aid has an uncertain impact on the macroeconomic variables of the beneficiary developing economies. Foreign aid boosts expenditure that appreciates the real exchange rate and move resources away from tradable into non-tradable goods production. This paper investigates the impact of increasing foreign aids by 30% from the base line on the aggregate Palestinian economy variables. A simulation is carried out using a 2012 Palestinian Social Accounting Matrix (SAM) and Computable General Equilibrium (CGE). The simulation results show that real GDP increases by 1.60 % and nominal GDP by 2.69%. The level of real private consumption increases by 10.01%.  Import increases by 11.21% and export decreases by 10.08 % in real term. The trade deficit increases by 31.64 %. Real exchange rate appreciated by 4.60% from the base line.   Absorption increases by 6.54% in real terms. This increase occurs through the domestic (non-tradable) price index, which increases by 1.50%.  Foreign aid inflows inflated the prices of non-traded goods. This reallocates resource from the production of traded goods to non-traded goods. Consequently, foreign aid inflows caused the Dutch disease effect in Palestine.

Keywords: Foreign aid, Dutch disease, Social Accounting Matrix, Computable General Equilibrium.