This paper estimates a model of fiscal response to analyse the impact of aid on government consumption and investment, tax revenue and public borrowing in Nicaragua in 1966–2004. This country is an interesting case study since aid flows—i.e. grants and aid loans—averaged more than 8 per cent of GDP during the analysed period. Results for direct (structural) effects indicate that the impact of aid on government consumption are more significant than those on government investment, revealing a higher propensity to consume than to invest aid flows, presumably reflecting donors and government priorities to finance social spending. Results also show that aid crowds-out both tax revenue and public borrowing. Estimates for total (reduced-form) effects are hard to interpret, in some cases showing the opposite sign than expected or implausible magnitudes. Copyright © 2009 John Wiley & Sons, Ltd.