International Financial Contagion and the IMF: A Theoretical Framework
September 1, 2001
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Summary
We provide a model of contagion where countries borrow or lend for consumption smoothing at the market interest rate or a lower IMF rate. Highly indebted countries hit by large negative shocks to output will default. The resulting reduction in loanable funds raises interest rates, increases the vulnerability of other indebted countries, and can generate further rounds of defaults. In this environment the IMF can limit default and internalize the externality generated by contagion through its lending with conditionality. We characterize the IMF's optimal lending decision in mitigating the loss in world consumption.
Subject: Consumption, Financial contagion, Financial crises, Financial institutions, Financial markets, Financial sector policy and analysis, International capital markets, Loans, Moral hazard, National accounts
Keywords: conditionality, Consumption, equilibrium interest rate, Financial contagion, fund conditionality, IMF, IMF charge, IMF subsidy, interest rate increase, International capital markets, international financial contagion, loan volume, loanable funds, Loans, Moral hazard, world capital market, world interest rate, WP
Pages:
31
Volume:
2001
DOI:
Issue:
137
Series:
Working Paper No. 2001/137
Stock No:
WPIEA1372001
ISBN:
9781451855913
ISSN:
1018-5941
