Toward a Lender of First Resort
26 Pages Posted: 26 Apr 2006
Date Written: March 2006
Abstract
If interest rates (country spreads) rise, debt can rapidly be subject to a snowball effect, which becomes self-fulfilling with regard to the fundamentals themselves. This is a market imperfection, because we cannot be confident that the unaided market will choose the 'good' over the 'bad' equilibrium. We propose a policy intervention to deal with this structural weakness in the mechanisms of international capital flows. This is based on a simple taxonomy that breaks down the origin of crises into three components: confidence (spreads and currency crisis), fundamentals (real growth rate), and economic policy (primary deficit). Theory then suggests a set of circumstances in which a lender of first resort would be desirable. The policy would seek to short-circuit confidence crises, partly by using IMF support to improve ex ante incentives. Theory also illuminates the potential role of collective action clauses in reducing the risk of self-fulfilling debt crises.
Keywords: market discipline, sovereign debt, country spreads, financial crises
JEL Classification: F33, F34
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
IMF Programs: Who is Chosen and What are the Effects?
By Robert J. Barro and Jong-wha Lee
-
Economic Determinants of Fund Financial Arrangements
By Malcolm Knight and Julio A. Santaella
-
Does IMF Financing Result in Moral Hazard?
By Timothy Lane and Steven Phillips
-
Does the IMF Cause Moral Hazard and Political Business Cycles? Evidence from Panel Data
By Axel Dreher and Roland Vaubel
-
The Macroeconomic Effects of Fund-Supported Adjustment Programs: An Empirical Assessment
-
Conditionality and Ownership in IMF Lending: A Political Economy Approach
By Allan Drazen
-
Debt Relief for Low-Income Countries and the Hipc Initiative
By Anthony Boote and Kamau Thugge