Foreign aid and fiscal behavior in a bounded rationality model: Different policy regimes

Abstract

We examine how the source of foreign aid affects the composition of the recipient government's spending. Does the source of aid – bilateral or multilateral – influence recipient policy-makers' choice between development and nondevelopment expenditure? We depart from previous literature by introducing strong asymmetries in policy-makers' preferences. With the financial constraints set by foreign aid and domestic revenues, this formalization allows us to model and estimate the fiscal behavior of government policy-makers in the presence of foreign aid.