The impact of foreign aid on money supply: a case study of Tanzania 1966-2003

Tanzania is among of developing countries, which has been highly depending on foreign aid as a source of her development finance. The country has benefited from both multilateral and bilateral inflows. This study therefore, examines the Impact of Foreign Aid on Money Supply in Tanzania from 1966 to 2003. The money supply function includes foreign aid, real GDP, deficit budget financing and deposit rate. The evidence from the Johansen Cointegration Test suggests two cointegrating equations at 5 percent. The Vector Error Correction method is supplied and the estimates suggest that, the first and second lags of ODA, DBF, and MS are found significant at 1 percent level of significant; DR is significant at first, second and third as where as RGDP is only significant at first lag. In addition, a dummy variable was also included as one of the explanatory variable to capture the economic changes brought about by the reform process. The general observations of the findings show that most important factors that determine money supply process are captured in the model. Given that foreign aid inflows affect significantly money supply in Tanzania, it justifies strong sterilization policy to mitigate the effects of the inflows and keep money supply on track.