The effects of aid on inflation : the role of financial market development

This thesis investigates the relationship between foreign aid and inflation considering the effect of financial market development (FMD) on this relationship. The main hypothesis is that aid has a significant positive impact on inflation. When the financial markets are developed enough, the upward effect of aid on inflation is expected to be diminished. The dynamic relationship is analyzed utilizing generalized method of moments (GMM) estimation which accommodates the use of an unbalanced panel data set, covering 60 countries in the period 1975-2004, where available. The results of the empirical analysis support the hypothesis. Furthermore, the results are robust to several control variables, and alternative measures of financial market development.