How does fiat currency help a country's economic growth? For example, if a certain country such as the U.S or Brazil gives 1billion dollars to a developing country like Angola or Congo, how does that money help build its economy? The fiat money we use today is an imaginary instrument. Federal Reserve prints 1 billion dollars and gives it to a developing country. How does that imaginary money, often in computer digits format, help improve the day to day life of the receiving country's people. It is just mind-boggling to think that if people receive money which is created from thin air, their life somehow improves. Can someone explain how all of this magic works in a most clear way?
How does that imaginary money, often in computer digits format, help improve the day to day life of the receiving country's people.
This is no magic trick. Of course, if recipient country would keep that foreign aid money locked in a museum as an art installation it would have no effect. However, money serve as a medium of exchange, people or organizations can exchange money for goods and services. For example, a country might use \$1 billion to improve nutrition by buying food and distributing it to the poor.
Even if the program is funded with newly created money which, ceteris pariubs, would lower their value the recipients would benefit, just the benefit in real terms would not be exactly equal to its nominal value.
How does foreign aid money help another country develop?
Foreign aid is actually highly controversial within the field of developmental economics so it is actually not clear at all if foreign aid money help, but this is for reasons having absolutely nothing to do with fiat money.
There are three main strands of literature when it comes to foreign aid:
- Foreign aid is harmful:
This is the view of scholars such as Easterly (2014) and Moyo (2010). It is argued that foreign aid fosters corruption in the country, since empirically a lot of aid money in many developing countries is spent on dubious projects that often help those with political connections rather than population at large. It is also argued that aid creates dependency. Next also aid represents a capital inflow to a country, this makes the currency of developing country more valuable as it causes it to appreciate. This might sound as a good thing, but in reality it hurts exports of the developing country, and leads to higher levels of unemployment in the short run.
- Foreign aid is not working because we did not spent enough:
The most prominent member of this camp is Stiglitz (2002). This camp basically argues that aid is on net beneficial and the previously mentioned drawbacks are overblown. It is argued that even if some of the aid money might end up in pockets of corrupt officials, it still funds programs that benefit people, and if we could just spend more on those programs it would help these countries develop faster.
- Foreign aid sometimes work and sometimes it is harmful so funding needs to be allocated on case by case basis by Randomized Control Trials (RCT)
This strand of literature is best represented by Banerjee and Duflo (2011) and Collier (2007). These authors basically argue that it is misleading to even try to answer the 'big question' of whether foreign aid works or not. They argue that sometimes it does and sometimes it doesn't. All aid programs should be evaluated and regularly re-evaluated using RCTs. Only programs where RCTs show substantial net benefit should be funded.
As mentioned earlier, there is no clear cut consensus among economists, so feel free to go over the sources cited in each of the three views and you can decide yourself which arguments make the most sense. However, as mentioned earlier, the literature on foreign aid does not consider fiat money a problem at all.