This paper examined impacts of food aid on domestic food production employing a computable general equilibrium modelling technique and using data from Ethiopia. The simulation experiments have shown that food aid has unambiguous disincentive effects on domestic food production. The removal of food aid caused a modest increase in food prices but this stimulated food production. Employment and income generation effects of the latter outweighed the adverse effect of the former. Consequently, the removal of food aid led to improvements in aggregate household welfare. Contrary to some concerns in the food aid literature that any reduction in food aid would hurt the poor, the simulation experiments suggested that actually poor rural household and urban wage earners are the ones who benefit most in absence of food aid but entrepreneurs are more likely to encounter a marginal welfare decline. We have distinguished between in-kind food aid and cash equivalent transfers in order to isolate the disincentives that in-kind transfers would make to domestic production from those that are related to household purchasing power problem. The expansionary effect of removing food aid becomes significantly larger when it is accompanied by cash equivalent payments because the latter would provide demand side stimulus to agriculture while the removal of in-kind transfers would stimulate supply side, with the supply and demand side effects reinforcing each other. Thus the multiplier effect of cash aid leads to improvements in welfare of households other than direct cash aid recipients (e.g. food producers and transport services) who would benefit from a higher demand for food in the domestic market. It follows that the apparent dichotomy between the two strands of the food aid literature, i.e., the “cash aid” versus “in-kind aid” debate and the controversy surrounding the disincentive hypothesis, virtually vanish as long as the multiplier effects of cash aid are taken into account in an economy-wide modelling framework. In our modelling framework, the only adverse effect would be a modest deterioration in the external current account, because the expansionary effects of food aid would cause imports to rise but exports to fall.