Unconditional IMF Financial Support and Investor Moral Hazard
IMF Working Papers, May 1, 2007
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Bibliographic details
- Authors: Jun I Kim
- Published: May 1, 2007
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451866681.001
Model and Calibration
- Develops a simple model of international lending in which:
- the country borrows in both short and long term;
- market (coordination) failure triggers a liquidity run and inefficient default;
- the IMF lends unconditionally under a preferred creditor status.
- Calibrates the model to assess quantitatively the effects of contingent IMF financial support on risk premiums and the crisis probability.
Main Findings
- IMF financial support can help prevent a liquidity crisis without causing investor moral hazard by removing a distortion that effectively subsidizes ex post short-term investors (who run for the exit) at the expense of long-term investors (who are locked in).
- The resulting equilibrium is welfare enhancing:
- the country's borrowing costs are lower;
- the likelihood of a crisis is lower.
- IMF-induced investor moral hazard—which occurs if the IMF lends at a subsidized rate—is unlikely to be a concern in practice, particularly if:
- the country's economic fundamentals are strong;
- short-term debt is small.
Policy Implications and Interpretation
- Unconditional IMF lending under preferred creditor status can play a crisis-prevention role by addressing coordination failures and liquidity runs.
- Concerns about investor moral hazard from IMF lending are mitigated when IMF support does not operate as a subsidy to investors or when country fundamentals and debt structure reduce vulnerability.