Abstract
Summary This paper examines the relationship between foreign aid inflows and the real exchange rate and assesses the potential for the aid-induced Dutch disease in Tanzania. Using cointegration technique and an error-correction model, the study found that aid inflows, increased openness of the economy and devaluation of the local currency caused real depreciation while increased government expenditure caused real appreciation. The finding that aid inflows caused real depreciation in Tanzania refutes the proposition that foreign aid has caused Dutch disease in the country. Tanzania may thus continue receiving aid and use it for productive investment to stimulate a positive supply response.
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