## The Mussa Theorem (and Other Results on IMF-Induced Moral Hazard)

_IMF Working Papers, October 1, 2004_

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## Bibliographic details
- Authors: Olivier D Jeanne, Jeromin Zettelmeyer
- Published: October 1, 2004
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451859799.001

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### Summary
- Using a simple model of international lending, the authors show that as long as the IMF lends at an actuarially fair interest rate and debtor governments maximize the welfare of their taxpayers, any changes in policy effort, capital flows, or borrowing costs in response to IMF crisis lending are efficient.
- Under these assumptions, the IMF cannot cause moral hazard, as argued by Michael Mussa (1999, 2004).
- It follows that examining the effects of IMF lending on capital flows or borrowing costs is not a useful strategy to test for IMF-induced moral hazard.
- Empirical research on moral hazard should instead focus on the assumptions of the Mussa theorem.

### Main findings
- Actuarially fair IMF lending combined with taxpayer-welfare-maximizing debtor governments implies:
  - Changes in policy effort in response to IMF crisis lending are efficient.
  - Changes in capital flows in response to IMF crisis lending are efficient.
  - Changes in borrowing costs in response to IMF crisis lending are efficient.
- Conclusion: Under the model’s assumptions, IMF lending does not generate moral hazard.

### Policy implications
- Tests for IMF-induced moral hazard should not rely on observed changes in:
  - Capital flows
  - Borrowing costs
- Instead, policy evaluation and empirical work should probe the validity of the Mussa theorem’s assumptions (notably actuarially fair lending rates and debtor government objectives).

### Research guidance and focus
- Empirical research on IMF-induced moral hazard should:
  - Focus on validating or rejecting the core assumptions of the Mussa theorem.
  - Avoid treating changes in capital flows or borrowing costs as direct evidence of moral hazard without examining underlying assumptions.

### Subjects and keywords
- Subjects: Capital flows, Emerging and frontier financial markets, Insurance, Loans, Moral hazard
- Keywords: debtor country, emerging market, IMF lending, WP

*Olivier D Jeanne and Jeromin Zettelmeyer, October 1, 2004.*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/the-mussa-theorem-and-other-results-on-imf-induced-moral-hazard-17709_