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Bulletin Logo    September 2000
Volume 1, Number 2
In This Issue

Research Summary
   International Lender of Last Resort
   Financial Contagion: ABC Channels

IMF Staff Papers Table of Contents (Volume 47, No. 1)

IMF Occasional Papers
   IMF Occasional Paper No. 192
   IMF Occasional Paper No. 193
   IMF Occasional Paper No. 194

Seminar on Financial Risks, System Stability, and Economic Globalization

External Publications by IMF Staff (January–June 2000)
   Journal Articles
   Other External Publications (Books, Conference Volumes)

Other IMF Publications, April–June 2000

Visiting Scholars at the IMF, April–June 2000

IMF Working Papers, April–June 2000

World Economic Outlook, May 2000

Research Summary
The IMF: An International Lender of Last Resort?
Olivier Jeanne

Since the 1994 Mexican crisis, the world has experienced several large financial rescue packages that were unprecedented in size and number. In the process, the IMF has refined its role as crisis manager, adopting newly designed facilities such as the Supplemental Reserve Facility (SRF) and Contingent Credit Lines (CCL). These changes in IMF lending practices have sometimes been interpreted as an evolution toward international lending in last resort—an evolution which, some have argued, should be further pursued and institutionalized.1 This summary reviews a selection of recent research papers that focus—or have some bearing—on the concept of international lending in last resort, and attempts to outline some directions in which this line of research is developing, particularly at the IMF itself.2

The balance sheets of crisis-hit emerging economies exhibited large maturity and currency mismatches in the period leading up to the crisis. In the event, borrowers—whether public, as in Mexico or Russia, or private, as in Asia—were unable to roll over short-term debt, often denominated in foreign currency and held by a large number of uncoordinated creditors.3 Whether or not the ensuing crises were self-fulfilling runs continues to be debated, but it is generally accepted that maturity and currency mismatches made the crises more contagious internationally and, overall, more difficult to contain.4 Against this background, the provision of official crisis lending was often justified as the response to a systemic liquidity problem—the sort of problem that a lender of last resort is supposed to cope with at the domestic level.

The need for an international lender of last resort can be rationalized by the fact that emerging economies’ external debt is mostly denominated in foreign currency, which national lenders of last resort hold in insufficient quantity to repay all creditors at short notice. From that perspective, the case for an international lender of last resort can be viewed as a simple transposition of the closed-economy analysis to the global level, the international lender of last resort providing the same service to central banks as the latter provide to their domestic banking sectors. The formal analogy between domestic and international lending in last resort is made clear by Goodhart and Huang (2000). In their model, the fragility of the banking sector and the limited ability of a domestic central bank to provide international liquidity to the interbank market can cause currency and banking crises. An international lender of last resort can then play a useful role in providing international liquidity and reducing international contagion.5

A too-direct transposition of the closed-economy analysis, however, may leave aside important aspects of the problem that are specific to the international dimension, argues Giannini (1999). In practice, domestic lending-in-last-resort policies and other financial safety nets are part of a broader policy and institutional framework that includes ex ante supervisory policies and powers of enforcement. The broader framework allows domestic policymakers to gather information, and to build a credible policy of “constructive ambiguity,” which help contain moral hazard and keep a reasonable degree of flexibility in responding to the unforeseeable circumstances of crises. Some features of the international environment, however, make it difficult to replicate this structure at the international level. This may explain why recent large-scale rescue packages have worked less than satisfactorily, according to Giannini.6

Another complication arises from the question of whether lending in last resort is intrinsically linked to the power of printing money or can be effectively implemented by an agency with a limited amount of resources. According to Capie (1998), effective international lending in last resort is impossible in the absence of an international currency issued by a global central bank. Eichengreen (1999) argues that, although an international lender of last resort does not necessarily have to print its own money, it would need an amount of hard currencies that is unrealistically large. The question of the required amount of resources for lending in last resort is crucial, since, as shown by Zettelmeyer (1999), lending less than the required amount may be worse than not lending at all.7

Jeanne and Wyplosz (2000) propose a formal framework to analyze the question of how large the international lender of last resort should be. They emphasize the importance of a distinction—originally made by Goodfriend and King (1988)—between “lending in last resort as an input in monetary policy” and “lending in last resort as an input in banking policy.”8 In the former case, the lender of last resort provides aggregate liquidity to the market in an anonymous way, counting on market forces to allocate it optimally to the illiquid but solvent institutions. In the latter case, the lender of last resort provides liquidity to specific institutions on non-market terms under some conditionality. Jeanne and Wyplosz argue that the resources required by international lending in last resort are likely to be much larger if they are used as an input in domestic monetary policy, since in this case a substantial fraction of the additional reserves will be used to finance speculative capital outflows. By contrast, making international lending in last resort an input in domestic banking policy (for example, by restricting its use to the service of an insurance on foreign currency deposits in domestic banks) is likely to require a more realistic amount of resources. The second policy, however, supposes a deeper involvement of the international lender of last resort in domestic financial supervision and safety nets than can be supported by current institutional arrangements.9

An important question—which I shall only touch upon in conclusion—is the implication of lending-in-last-resort in terms of moral hazard. The recent international bailouts have been widely criticized for generating moral hazard, which encourages both emerging market countries and their creditors to undertake imprudent risks that ultimately materialize in damaging financial crises.10 This criticism would apply with even more force if bailouts came to be institutionalized as part of a systematic international lending-in-last-resort policy. As argued by Mussa (1999), however, the fact that insurance generates moral hazard is a universal argument against all forms of insurance. The more relevant question is whether moral hazard is contained within appropriate bounds, when compared with the real benefits of insurance. In a closed-economy context, the domestic authorities have to balance the benefits of financial safety nets in the event of a crisis against their implications in terms of moral hazard ex ante; and the terms of this trade-off can be improved ex ante by adequate regulation and supervision. As argued by Jeanne and Zettelmeyer (2000), international moral hazard could, in principle, be mitigated by making the extent of the lender-of-last-resort’s commitment to lend in the event of crisis conditional on the quality of domestic financial policies. Kumar, Masson and Miller (2000), on the other hand, argue that restricting international lending-in-last-resort to prequalified countries would increase instability.11

[Acknowledgments: This summary benefited from comments by Jeromin Zettelmeyer.]

1See, for example, Fischer, “On the Need for an International Lender of Last Resort,” Journal of Economic Perspectives, 1999, pp. 85–104.
2This note focuses on the potential benefits of an international lender of last resort for emerging economies. Related issues are discussed in connection with financial stability in the euro area by Prati and Schinasi, “Will the European Central Bank Be the Lender of Last Resort in EMU?,” in The Euro: A Challenge and Opportunity for Financial Markets (edited by M. Artis, A. Weber, and E. Hennessy; Routledge: New York), 2000, pp. 227–256.
3Fragilities in the balance sheet of emerging economies are at the core of many recent models of currency and financial crises; see, for example, Caballero and Krishnamurthy, “Emerging Market Crisis: An Asset Market Perspective” (IMF Working Paper 99/129) and Chang and Velasco, “Liquidity Crises in Emerging Markets: Theory and Policy,” 1999, NBER Working Paper No. 7272.
4Bussière and Mulder (1999) find that liquidity-related variables are important in explaining the international propagation of crises in “External Vulnerability in Emerging Market Economies: How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion” (IMF Working Paper 99/88). See also Detragiache and Spilimbergo, “Crises and Liquidity: Evidence and Interpretation,” 2000 (IMF Working Paper, forthcoming).
5Goodhart and Huang, “A Simple Model of an International Lender of Last Resort” (IMF Working Paper 00/75).
6Giannini, “Enemy of None but Friend of All? An International Perspective on the Lender of Last Resort Function” (IMF Working Paper 99/10).
7Capie, “Can There Be an International Lender-of-Last-Resort?,” 1998, International Finance, pp. 311–325; Eichengreen, Toward a New International Financial Architecture, Institute for International Economics, 1999; Zettelmeyer, “Can Official Crisis Lending Be Counterproductive in the Short Run?,” 2000, Economic Notes, pp. 13–29.
8Goodfriend and King, “Financial Deregulation, Monetary Policy and Central Banking,” in Restructuring Banking and Financial Services in America, Haraf and Kushmeider, eds., American Enterprise Institute and UPA: Lanham (MD), 1988.
9Jeanne and Wyplosz, “The International Lender of Last Resort: How Large Is Large Enough?” (IMF Working Paper, forthcoming).
10See Lane and Phillips, “Moral Hazard in IMF Financing” (1999, mimeo, IMF) for an attempt to test for the consequences of IMF lending in terms of moral hazard. Lane and Phillips test for moral hazard by examining market reactions to IMF-related policy announcements over the last five years, with mixed results.
11Mussa, “Reforming the International Financial Architecture: Limiting Moral Hazard and Containing Real Hazard,” (2000, mimeo, IMF); Jeanne and Zettelmeyer, “International Bailouts and Moral Hazard: the International Connection” (IMF Working Paper, forthcoming); Kumar, Masson and Miller, "Global Financial Crises: Institutions and Incentives" (IMF Working Paper 00/105).

Research Summary
Financial Contagion: ABC Channels
Haizhou Huang

Recent financial crises—those in Mexico, Asia, and Russia, in particular—have been accompanied by episodes of international financial market contagion. These crises fueled fears of systemic failure and global financial meltdown and raised important questions about financial contagion. For example, what are the main channels that transmit financial crisis from one country to another? How can international financial contagion be contained? These questions, central to the IMF’s role in the financial sector, have been an area of active research within the IMF and in the academic community. This brief note provides a short summary of research done on this topic at the IMF in recent years.

The literature on financial contagion focuses on the cross-country patterns of financial market contagion, an area in which the conventional macroeconomic explanations appear to be implausible. As discussed in Masson (1999a, 1999b), financial contagion may arise because of spillovers and jumps between multiple equilibria in international financial markets.1 The literature identifies three main channels for financial contagion, i.e., the Asset market channel, the Banking channel, and the Currency channel, which we term the ABC channels.2

The strand of literature on the asset channel abstracts from potential macroeconomic determinants of contagion and instead focuses on contagion as a financial market phenomenon. Extending an argument by King and Wadhawani (1990)—in that changes in the prices of assets in one market imperfectly reveal information on changes in the value of assets in other markets—Kodres and Pritsker (1998) build a multiasset rational expectations model in which, even if information is restricted to be uncorrelated across markets, contagion can still occur.3 Schinasi and Smith (1999) argue that the existence of financial contagion does not necessarily require recourse to market imperfections.4 In response to a shock to one asset, investors could find it optimal to sell many high-risk assets if they were leveraged and wished to diversify their investments and, thus, contagion in asset markets would emerge.

The asset channel of financial contagion is useful in explaining recent financial crises in emerging markets. Caballero and Krishnamuthy (1999) show that fire sales of domestic assets and possibly foreign exchange, together with the combination of weak international financial links and underdeveloped domestic financial markets, can trigger international financial crises in emerging markets.5

The strand of the literature on the banking channel seeks to extend the seminal contribution of Diamond and Dybvig (1983) from a run on one bank to a collapse of the entire banking system. The main building block of the banking channel is imperfection in the interbank market due to either information asymmetry or limited availability of liquidity.6 Aghion, Bolton, and Dewatripont (1999) show that the limited availability of liquidity in the domestic interbank market can cause contagious bank failures, because depositors, after observing a bank run, should draw the conclusion that liquidity in the interbank market has been exhausted and thus may start to run on their own banks.7 Huang and Xu (2000) argue that, because of information asymmetry among banks trading in the interbank market, a serious “lemon” problem in this market would prevent banks with liquidity surplus from lending to those in liquidity shortage, and thus lead to a collapse of the entire interbank market.8

The third strand of literature on financial contagion focuses on the currency channel. Flood (1999) and Jeanne (2000) provide excellent surveys on this topic.9 Empirical evidence, such as in Baig and Goldfajn (1998), emphasizes that correlations in currency and sovereign spreads increased significantly during the Asian crisis, whereas the equity market correlations offer mixed evidence.10 Jeanne (1998) shows that international liquidity mismatch plays an important role in creating conditions for currency crises. Jeanne (1997) and Jeanne and Masson (2000) highlight the importance of sunspots in explaining currency crises.11 In a study on transition economies of Central and Eastern Europe, Russia, and the Baltics, Gelos and Sahay (2000) find that financial spillover patterns since 1993 in the more advanced transition economies were similar to those in their Asian and Latin American counterparts.12

Since a currency crisis often triggers a banking crisis, and vice versa, both the banking and currency channels may work together and generate the so-called “twin crises.” Goldfajn and Valdes (1997) examine the twin crises in a unified framework whereby the interaction between exchange rate collapses and bank runs transmits a currency crisis to a banking crisis and vice versa.13 Goodhart and Huang (2000) show that, when central banks operate under pegged exchange rate regimes, the fragility of the banking system and the limited ability of a domestic central bank to provide international liquidity together can cause contagion in the international interbank market, which can further lead to twin crises in many economies.14

The ABC channels of financial contagion have important implications about how to contain contagion.15 The literature on the asset channel suggests that more diversification may raise costs of financial contagion. It emphasizes the importance of asset market fundamentals. The literature on the banking channel highlights the critical role of financial institutions, in particular, the interbank market in generating information and trading liquidity, the central bank in providing urgent liquidity, and the availability of an international lender of last resort.16 The currency channel literature emphasizes the importance of external imbalances.

[Acknowledgment: R. Barry Johnston provided useful comments.]

1Masson, “Contagion: Monsoonal Effects, Spillovers and Jumps between Multiple Equilibria,” in Agenor, Miller, Vine and Weber, eds., The Asian Financial Crises: Causes, Contagion and Consequences, Cambridge University Press, 1999a; “Multiple Equilibria, Contagion, and the Emerging Markets Crises” (IMF Working Paper 99/164), forthcoming in Glick, Moreno, and Spiegel, eds., Financial Crises in Emerging Markets, Cambridge University Press, 1999b.
2For evidence supporting financial channels for transmitting contagion, see Van Rijckeghem and Weder, “Sources of Contagion: Finance and Trade?” (IMF Working Paper 99/146), forthcoming in Journal of International Economics; Caramazza, Ricci, and Salgado, “Trade and Financial Contagion in Currency Crises” (IMF Working Paper 00/55); and Hernández and Valdés, “What Drives Contagion? Trade, Neighborhood, and Financial Links,” forthcoming IMF Working Paper.
3King and Wadhawani, “Transmission of Volatility between Stock Markets,” Review of Financial Studies, 1990, pp. 5–33; Kodres and Pritsker, “A Rational Expectations Model of Financial Contagion” mimeo, Oct. 1998, IMF and the Board of Governors of the Federal Reserve System.
4Schinasi and Smith, “Portfolio Diversification, Leverage, and Financial Contagion,” (IMF Working Paper 99/136).
5Caballero and Krishnamuthy, “Emerging Markets Crisis: An Asset Markets Perspective” (IMF Working Paper 99/129). On the effects of fundamentals in explaining contagion in emerging economies, see Levy-Yeyati and Ubide, “Crises, Contagion, and the Closed-End Country Fund Puzzle” (IMF Working Paper 98/143), forthcoming in IMF Staff Papers; and Bussiere and Mulder, “External Vulnerability in Emerging Market Economies: How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion” (IMF Working Paper 99/88).
6Diamond and Dybvig, “Bank Runs, Deposit Insurance and Liquidity,” Journal of Political Economy, 1983, pp. 401–419.
7Aghion, Bolton, and Dewatripont, “Contagious Bank Failures,” mimeo, University College London, Princeton University and ECARE, Sept. 1999.
8Huang and Xu, “Financial Institutions, Financial Contagion, and Financial Crises” (IMF Working Paper 00/92).
9Flood, “Perspectives on the Currency Crises Literature,” International Journal of Finance and Economics, Jan. 1999, pp. 1–26; Jeanne, “Currency Crises: A Perspective on recent Theoretical Developments,” Special Papers in International Economics, March 2000.
10Baig and Goldfajn, “Financial Markets Contagion in the Asian Crises” (IMF Working Paper 98/155), IMF Staff Papers, June 1999, pp. 167–195.
11Jeanne, “The International Liquidity Mismatch and the “New Architecture” (1998, IMF manuscript); Jeanne, “Are Currency Crises Self-Fulfilling? A Test,” Journal of International Economics, Nov. 1997, pp. 263–86; Jeanne and Masson, “Currency Crises, Sunspots and Markov-Switching,” Journal of International Economics, April 2000, pp. 327–50.
12Gelos and Sahay, “Financial Market Spillover in Transition Economies” (IMF Working Paper 00/71). For a study on the features of China’s trade and financial system that helped insulate it from the contagion effects of the crisis, see Fernald and Loungani, “Countering Contagion: Does China’s Experience Offer a Blueprint?” forthcoming IMF Working Paper. For studies on contagious currency crises in emerging economies, see Ahluwalia, “Discriminating Contagion: An Alternative Explanation of Contagious Currency Crises in Emerging Economies,” (IMF Working Paper 00/14); and Nagayasu, “Currency Crisis and Contagion: Evidence from Exchange Rates and Sectoral Stock Indices of the Philippines and Thailand,” (IMF Working Paper 00/39).
13Goldfajn and Valdes, “Capital Flows and the Twin Crises: The Role of Liquidity” (IMF Working Paper 97/87).
14Goodhart and Huang, “A Simple Model of an International Lender of Last Resort” (IMF Working Paper 00/75). Clark and Huang, in a forthcoming IMF Working Paper entitled “International Financial Contagion, Systemic Vulnerability, and the Fund,” show that international financial contagion can arise in very general settings.
15See Johnston, Chai, and Schumacher, “Assessing Financial System Vulnerabilities” (IMF Working Paper 00/76), for discussions on the IMF’s Financial System Stability Assessment (FSSA) program.
16Fischer analyzes the need for an international lender of last resort in “On the Need for an International Lender of Last Resort,” speech given at the joint luncheon of the American Economic Association and the American Finance Association, New York, January 3, 1999, and published in Journal of Economic Perspectives, Fall 1999, pp. 85–104. Jeanne (2000) provides a summary on the topic of international lending in last resort in this issue of the IMF Research Bulletin.

IMF Staff Papers
Volume 47, No. 1

The Rise and Fall of Pyramid Schemes in Albania
Chris Jarvis

International Trade and Productivity Growth: Exploring the Sectoral Effects for Developing Countries
Ehsan U. Choudhri and Dalia S. Hakura

Crises, Contagion, and the Closed-End Country Fund Puzzle
Eduardo Levy-Yeyati and Angel Ubide

Intragenerational Redistributive Effects of Unfunded Pension Programs
Luis Cubeddu

The Long-Run Relationship Between Real Exchange Rates and Real Interest Rate Differentials: A Panel Study
Ronald MacDonald and Jun Nagayasu

Sources of Economic Growth: An Extensive Growth Accounting Exercise
Abdelhak Senhadji

IMF Staff Papers, the IMF’s scholarly journal, edited by Robert Flood, publishes selected high-quality research produced by IMF staff and invited guests on a variety of topics of interest to a broad audience including academics and policymakers in IMF member countries. The papers selected for publication in the journal are subject to a rigorous review process using both internal and external referees. The journal and its contents (including an archive of articles from past issues) are available online at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

IMF Occasional Papers

IMF Occasional Paper No. 192
Macroprudential Indicators of Financial System Soundness
Owen Evans, Alfredo M. Leone, Mahinder Gill, and Paul Hilbers

Macroprudential indicators—defined broadly as indicators of the health and stability of financial systems—can help countries assess the vulnerability of their banking systems to crises. Work in this area has grown significantly in recent years, as part of the efforts to strengthen the architecture of the international financial system.

This paper takes stock of current knowledge on macroprudential indicators—notably, analytical, identification, and measurement issues—based on a survey of the literature and of ongoing work by multilateral institutions, national central banks and supervisory authorities, and rating agencies. The indicators covered encompass both aggregated indicators of the health of individual financial institutions and their borrowers, and macroeconomic variables associated with financial system soundness. The paper also looks at issues related to the use of macroprudential indicators in IMF surveillance (including in the context of the Financial Sector Assessment Program), and possible ways to encourage their dissemination to the public.

Detailed contents of IMF Occasional Papers are available at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

IMF Occasional Paper No. 193
Exchange Rate Regimes in an Increasingly Integrated World Economy
Michael Mussa, Paul Masson, Alexander Swoboda, Esteban Jadresic, Paolo Mauro, and Andrew Berg

This paper considers the choice of an appropriate exchange rate regime for individual countries in light of important recent changes in the world economy, in particular the general increase in capital mobility and the abrupt reversals of capital flows to developing and transition countries. The authors conclude that no single exchange rate regime is best for all countries in all circumstances. While increased capital mobility has made exchange rate commitments more difficult to sustain unless buttressed by a currency board or monetary union, thereby increasing the prevalence of floating exchange rates in emerging market countries, intermediate regimes such as adjustable and crawling pegs or bands are likely to remain viable, especially for developing countries whose exposure to global financial markets remains limited.

Whatever regime is chosen, however, must be supported by policies consistent with it. As concerns the exchange rate regimes for the world’s major currencies, the dollar, euro, and yen are likely to continue to float, as those economies continue to devote their monetary policies to domestic objectives. The paper also discusses the IMF’s advice to member countries on exchange rate arrangements and provides statistical information on exchange rate regimes across the world.

Detailed contents of IMF Occasional Papers are available at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

IMF Occasional Paper No. 194
Fiscal and Macroeconomic Impact of Privatization
Jeffrey Davis, Rolando Ossowski, Thomas Richardson, and Steven Barnet

Privatization has been a key element of structural reform in many developing and transition economies during the last decade. This paper examines the fiscal and macroeconomic issues involved in the privatization of nonfinancial public enterprises in these economies. It considers issues such as the factors determining the proceeds from privatization and the amount accruing to the budget, the uses of such proceeds, the impact of privatization on the budget and on macroeconomic aggregates, and the privatization component of IMF-supported programs.

The empirical evidence draws on case studies of countries that reflect geographical diversity and that are representative of a range of privatization experiences in developing and transition economies. Data from the case-study countries suggest that privatization receipts channeled through the budget are usually saved rather than spent, while other evidence suggests that, over time, the fiscal situation tends to benefit from privatization, with greater revenues, lower transfers, and a narrowing of deficits and possibly also of quasi-fiscal operations.

Detailed contents of IMF Occasional Papers are available at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

Seminar on Financial Risks, System Stability, and Economic Globalization
Omotunde E. G. Johnson

The eighth Central Banking Seminar of the IMF was held June 5–8, 2000. It was organized by the IMF’s Monetary and Exchange Affairs Department, in collaboration with the IMF Institute.

In his opening remarks, First Deputy Managing Director Stanley Fischer described the changing role of the IMF in the financial sector and noted the growing importance of international standards in this area. Fischer noted that the crises that swept emerging market nations in recent years left no one in any doubt about the importance of a strong and well-regulated financial sector in dealing with capital flows. But in re-examining the proper role of the IMF in the wake of these crises, he thought it fair to ask how the institution should incorporate structural and other policies into its normal activities without moving too far away from its central mandate with respect to macroeconomic policy. He underscored the rationale for the IMF’s involvement in financial sector issues; namely, that the effectiveness of the economic policies the IMF supports depends enormously on the state of the financial sector.

David Stephen and Michael Fischer (Credit Suisse/First Boston) described internal rating processes and models and discussed the issues that CSFB had faced in designing and implementing its internal ratings process. An appropriate risk management system should comprise both quantitative models as well as processes (building databases, validation and benchmarking, testing and maintenance, review and audit).

Charles Monet (J. P. Morgan & Co) presented a technical paper on addressing the problem of “wrong way credit exposure”—handling trades when there is an adverse relationship between exposure size and counterparty default (exposure increasing at “the wrong time”). Monet underscored the need to model market and credit risk in an integrated fashion in order to have better estimates of the amounts exposed to counterparties.

Christopher Mahoney (Moody’s Investor’s Service) argued that four factors could help identify vulnerability: systemic solvency (the proportion of a system’s banks that are insolvent); accounting transparency (opaque or bogus accounting); quality of supervision (lax supervision); and funding stability (excessive reliance upon hot or noncore funding). He argued that these four factors were necessary but not sufficient to cause a banking crisis. Rather two things were sufficient: the injudicious introduction of market discipline (into a weak financial system), and an external payments crisis.

David Llewellyn (Loughborough University, U.K.) argued that there were seven major components of a regulatory regime and that the objective of public policy should be an optimal combination of those components in the design and implementation of an appropriate regulatory strategy. He stressed the complementarity of the seven components and argued that the optimal mix would change over time as market conditions and compliance culture change.

Koichi Hamada (Yale University) discussed the welfare costs of systemic risk, financial instability, and financial crises. He illustrated, under some simplifying assumptions, that the welfare loss (especially in terms of output and employment) from a systemic crisis will depend on the probability of the crisis occurring, the duration of the crisis, the recovery rate of defective claims and other damages, and the availability of facilities to dampen the disruption (such as lender-of-last-resort facilities). He pointed out that the welfare cost of a financial crisis would depend on the monetary regime.

Hiroshi Nakaso (Bank of Japan) outlined some important features of the financial crisis of Japan, which lasted with various degrees of severity for most of the 1990s; the factors behind the crisis; and the conclusions and lessons that could be drawn for early warning signals of banking crises. A central argument of his presentation was that, in addition to general economic and market indicators, bank behavior could provide early clues to the development of problems in the financial sector.

Edward Kane (Boston College) reviewed the costs and benefits that fully informed creditors would consider in deciding whether to recapitalize or liquidate an insolvent corporation. He went on to identify the additional concerns and conflicts of interest that incompletely informed taxpayers face when government regulators with short horizons manage the insolvency of giant banks. In this context, regulatory decisions may exhibit dynamic inconsistency because opportunistic forbearance offers personal and bureaucratic rewards, and officials who confront bank insolvency in a timely way are threatened with substantial reputational and career penalties. The model also indicated that dynamically inconsistent capital forbearance could emerge because current taxpayers believe they can shift the costs of resolving bank insolvencies to future taxpayers.

Akira Ariyoshi (IMF) surveyed a number of issues related to the subject of international capital mobility and domestic financial system stability. His basic message was that capital mobility had major implications for financial system stability.

Andrew Powell (Central Bank of Argentina) argued that emerging market economies should pursue safety-first strategies in their monetary and financial policies. He cited three important policy areas to illustrate the implications of a safety-first strategy: exchange rate regimes, liquidity policies, and banking sector policies.

Jeffrey Davis and Timo Valila (IMF) surveyed the main analytical issues related to fiscal support in financial sector restructuring and illustrated their analysis by discussing the recent experience of Korea and Thailand. They argued that the main role of fiscal policy in financial sector restructuring was to extend financial support in a cost-effective and efficient, transparent, and equitable way so as to minimize the risk of having to deal with moral hazard problems. The use of fiscal instruments should preferably be accompanied by operational and structural reforms aimed at addressing underlying problems.

Ydahlia Metzgen (IMF) summarized the various initiatives at the national and international level being pursued to improve the functioning of national and international financial markets, took stock of progress to date, and offered a view of the challenges that lay ahead. She highlighted important initiatives in which the IMF had been active, including the Financial Sector Assessment Program. The IMF’s multilateral surveillance of international economic and financial market developments had expanded and was playing an important role in focusing the international community’s attention on the key financial market issues. The IMF was also devoting increasing attention to regional surveillance and technical assistance.

Stefan Ingves (IMF) discussed the Financial Sector Assessment Program (FSAP): its purpose, process, and the technical nature of its content. He also discussed the Financial System Stability Assessment (FSSA), which is the paper prepared by the IMF staff for its Executive Board following the IMF-World Bank FSAP mission and report for the country authorities. The FSAP program is designed to identify and assess financial system strengths and vulnerabilities from the perspective of best practice. Ingves discussed some of the analytical approaches, including stress testing, used by FSAP missions. Linked to FSAP, there is substantial financial sector analytical work under way in the IMF, particularly to develop macroprudential indicators.

In a luncheon speech, Orio Giarini (Editor of Geneva Papers on Risk and Insurance) underlined the importance of the insurance industry in the financial sector—in risk management and risk transfer. He noted that governments had increasingly come to realize that promoting an efficient private insurance system was important in ensuring a sound financial system. Malcolm Knight (Bank of Canada), in his luncheon speech, discussed the role of the central bank in fostering financial system stability and the experience of the Bank of Canada in particular. A panel, comprising André Icard (Bank for International Settlements), Carl Lindgren (IMF), and Manuel Conthe (World Bank) discussed the changing role of the IMF and the World Bank in assessing and promoting financial system soundness in a global setting. Deputy Managing Director Eduardo Aninat, in his closing remarks highlighted some of the main conclusions of the four days of discussions.

A more detailed conference summary can be found at http://www.imf.org/external/pubs/res/index.htm. Follow the link to IMF Conferences, Seminars, and Workshops.

External Publications by IMF Staff
January–June 2000

Journal Articles

Beyer, Hans-Joachim; Dziobek, Claudia; Garrett, John R.
Lessons from Privatization of DePfa and Fannie Mae

Bogetic, Zeljko
Full Dollarization: Fad or Future?

Brett, Craig; Keen, Michael
Political Uncertainty and the Earmarking of Environmental Taxes
Journal of Public Economics

Brixiova, Zuzana; Yousef, Tarik
Labor Market Adjustment in Transition Economies with On-the-Job Search
Economics Letters

Bulir, Ales; Gulde, Anne-Marie
Inflation and Income Distribution
Finance a uver

Christoffersen, Peter; Giorgianni, Lorenzo
Interest-Rate Arbitrage in Currency Baskets: Forecasting Weights and Measuring Risk
Journal of Business and Economic Statistics

de Mello, Luiz
Fiscal Decentralization and Intergovernmental Fiscal Relations: A Cross-Country Analysis
World Development

Detragiache, Enrica; Garella, Paolo; Guiso, Luigi
Multiple vs. Single Banking Relationships: Theory and Empirical Evidence
Journal of Finance

Drees, Burkhard; Eckwert, Bernhard
Price Volatility and Risk with Non-Separability of Preferences
Mathematical Social Sciences

Flood, Robert; Marion, Nancy P.
Self-Fulfilling Risk Predictions: An Application to Speculative Attacks
Journal of International Economics

Garfinkel, Michelle; Lee, Jaewoo
Political Influence and the Dynamic Consistency of Policy
American Economic Review

Ghosal, Vivek; Loungani, Prakash
The Differential Impact of Uncertainty on Investment in Small and Large Businesses
Review of Economics and Statistics

Goulder, Lawrence H.; Mathai, Koshy
Optimal CO2 Abatement in the Presence of Induced Technological Change
Journal of Environmental Economics and Management

Guillaume, Dominique; Stasavage, D.
Improving Policy Credibility. The Case for African Monetary Unions
World Development

Jeanne, Olivier; Masson, Paul
Currency Crises, Sunspots and Markov-Switching Regimes
Journal of International Economics

Keen, Michael
The Balance Between Specific and Ad Valorem Taxation
Fiscal Studies

Keen, Michael; Papapanagos, Harry; Shorrocks, Anthony F.
Tax Reform and Progressivity
Economic Journal

Lee, Jaewoo; Shin, Kwanho
The Role of a Variable Input in the Relationship Between Investment and Uncertainty
American Economic Review

Rodriguez, Edgard; Tiongson, Erwin
Temporary Migration Overseas and Household Labor Supply: Evidence from Urban Philippines
International Migration Review

Tanzi, Vito; Zee, Howell
Taxation and the Household Saving Rate: Evidence from OECD Countries
Banca Nazionale del Lavoro Quarterly Review

Tanzi, Vito; Zee, Howell
Tax Policy for Emerging Markets: Developing Countries
National Tax Journal

Thustrup Hansen, Claus; Haagen Pedersen, Lars; Sløek, Torsten
Ambiguous Effects of Tax Progressivity—Theory and Danish Evidence
Labour Economics

Other External Publications (Books, Conference Volumes)

Bigman, David; Dercon, Stefan; Guillaume, Dominique
Community Targeting for Poverty Reduction in Burkina Faso
Geographical Targeting for Poverty Reduction. Bigman D. and Foffack H. (eds.). The World Bank.

Boadway, Robin; Keen, Michael
Handbook of Income Distribution, North-Holland. A.B. Atkinson and F. Bourguignon (eds).

Bogetic, Zeljko
Economías ya Dolarizadas
Perfiles del Siglo XXI (Mexico)

de Mello, Luiz
Privatization and Corporate Governance in Brazil
Privatization in Brazil: The Case of Public Utilities, A.C. Pinheiro and K. Fukasaku, eds. (Rio de Janeiro: OECD Development Center). Guillaume, Dominique
Intra-Daily Foreign Exchange Rate Movements
Kluwer Academic Publishers

Havrylyshyn, Oleh; Kunzel, Peter
Intra-Industry Trade of Arab Countries: An Indicator of Potential Competitiviness
Catching Up with the Competition: Trade Opportunities and Challenges for Arab Countries, Bernard Hoekman and Jamel Zarrouk (eds.). Ann Arbor: University of Michigan Press.

Havrylyshyn, Oleh; McGettigan, Donald
Privatization in Transition Countries: A Sampling of the Literature
Post Soviet Affairs

Henneberger, Fred; Graf, Stefan; Vocke, Matthias
Globalisierung und Arbeitsmarkt: Auslandsinvestitionen von Dienstleistungsunternehmen und ihre Auswirkungen auf die Beschäftigung (Baden-Baden: Nomos Verlag).

Jeanne, Olivier
Currency Crises: A Perspective on Recent Theoretical Developments
Princeton Studies in International Finance

Jeanne, Olivier
Foreign Currency Debt and the Global Financial Architecture
European Economic Review. Papers and Proceedings

Keen, Michael
VIVAT, CVAT, and All That: New Forms of VAT for Federal Systems
Canadian Tax Journal

Ley, Eduardo; Macauley, Molly; Salant, Steve
Stop the Trash Trade
American Economic Review, Papers and Proceedings

Murray, John; Zelmer, Mark; Antia, Zahir
International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada
Bank of Canada Technical Report. Ottawa: Bank of Canada.

Mussa, Michael
Reforming the International Financial Architecture: Limiting Moral Hazard and Containing Real Hazard
Capital Flows and the International Financial System, edited by D. Gruen and L. Gower (Australia: J.S. McMillan Printing Group)

Nagy, Piroska
The Meltdown of the Russian State
Edward Elgar, Cheltenham, UK, and Northampton,
US. Publishers

Prati, Alessandro; Schinasi, Garry
Will the European Central Bank Be the Lender of Last Resort in EMU?
The Euro. A Challenge and Opportunity for Financial Markets (edited by M. Artis, A. Weber, and E. Hennessy; Routledge, New York)

Sakellaris, Plutarchos; Spilimbergo, Antonio
Business Cycle and Investment in Human Capital: International Evidence on Higher Education
Carnegie-Rochester Conference Series on Public Policy

Tanzi, Vito
Policies, Institutions, and the Dark Side of Economics
Northampton, Mass.

Thuronyi, Victor (editor)
Tax Law Design and Drafting
Kluwer Law International

Zhou, Jianping
Roots of the Financial Crisis in Asia and Implications for China
Financial Market Reform in China, edited by B. Chen, J. Dietrich, and Y. Feng (Westview Press).

A full and updated listing of external publications of IMF staff (from 1997 onward), including forthcoming publications, can be found in a searchable database at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

Other IMF Publications
April–June 2000

Policy Discussion Papers
Policy Discussion Paper PDP/00/3
Exchange Rate Regimes in Selected Advanced Transition Economies - Coping with Transition, Capital Inflows, and EU Accession
Corker, Robert; Beaumont, Craig; van Elkan, Rachel; Iakova, Dora

Policy Discussion Paper PDP/00/4
Raising Growth and Investment in Sub-Saharan Africa - What Can be Done?
Hernandez-Cata, Ernesto

Policy Discussion Paper PDP/00/5
The Role of MULTIMOD in the IMF’s Policy Analysis
Isard, Peter

Policy Discussion Paper PDP/00/6
Capital Flight from Russia
Loungani, Prakash; Mauro, Paolo

Economic Issues
Economic Issues No. 20
Job Creation: Why Some Countries Do Better
Garibaldi, Pietro; Mauro, Paolo

Pamphlet Series
Pamphlet Series, No. 45
Financial Organization and Operations of the IMF

Visiting Scholars at the IMF, April–June 2000

Auernheimer, Leonardo; Texas A&M University
Barr, Nicholas; London School of Economics, U.K.
Berglof, Erik; Stockholm Institute of Transition Economics, Sweden
Binder, Michael; University of Maryland
Boone, Laurence; OCED, France
Branson, William; Princeton University
Christiano, Lawrence; Northwestern University
Christoffersen, Peter; McGill University, Canada
Cosimano, Thomas; University of Notre Dame
Disney, Richard; University Park, Worthington, England
Dixit, Avinash; Princeton University
Drazen, Allan; University of Maryland
Feltenstein, Andrew; Virginia Polytechnic Institute
Gbetnkom, Daniel; University of Yaounde II-Soa, Cameroon
Hillman, Arye; Bar-Ilan University, Ramat Gan, Israel
Keane, Michael; New York University
Krishna, Kala; Pennsylvania State University
Kroszner, Randall; University of Chicago
Lane, Philip; Trinity College Dublin, Ireland
Mariara, Jane; University of Nairobi, Kenya
McCallum, Bennett; Carnegie-Mellon University
McDermott, John; Reserve Bank of New Zealand
Miller, Marcus; University of Warwick, England
Moers, Lucas; Tinbergen Institute/University of Amsterdam, Netherlands
Montiel, Peter; Williams College
Ngugi, Rose; University of Nairobi, Kenya
Omole, Davidson; National University of Lesotho, Lesotho
Pestieau, Pierre; University of Liege, Belgium
Roland, Gerard; ECARE University of Brussels, Belgium
Smith, Richard Todd; University of Alberta, Canada
Sorensen, Peter B.; University of Copenhagen, Denmark
Stavrev, Emil; Czech National Bank, Czech Republic
Weber, Shlomo; Southern Methodist University
Wihlborg, Clas; University of Goteborg, Sweden
Yafeh, Yishay; The Hebrew University, Israel
Zahler, Roberto; Zahler & Co., Chile

IMF Working Papers
April–June 2000

Working Paper No. 00/71
Financial Market Spillovers in Transition Economies
Gelos, R. Gaston; Sahay, Ratna

Working Paper No. 00/72
Terms of Trade Shocks in Africa—Are They Short-Lived or Long-Lived?
Cashin, Paul; Pattillo, Catherine

Working Paper No. 00/73
Caribbean Approaches to Economic Stabilization
Hilaire, Alvin

Working Paper No. 00/74
Social Capital and Civil Society
Fukuyama, Francis

Working Paper No. 00/75
A Simple Model of an International Lender of Last Resort
Goodhart, Charles; Haizhou Huang

Working Paper No. 00/76
Assessing Financial System Vulnerabilities
Johnston, R. Barry; Chai, Jingqing; Schumacher, Liliana

Working Paper No. 00/77
How Accurate Are Private Sector Forecasts—Cross-Country Evidence from Consensus Forecasts of Output Growth
Loungani, Prakash

Working Paper No. 00/78
Rural Poverty in Developing Countries—Issues and Policies
Khan, Mahmood H.

Working Paper No. 00/79
Emergency Liquidity Support Facilities
He, Dong

Working Paper No. 00/80
Seasonality and Capacity—An Application to Italy
de Blasio, Guido; Mini, Federico

Working Paper No. 00/81
Assessing Fiscal Sustainability in Theory and Practice
Chalk, Nigel; Hemming, Richard

Working Paper No. 00/82
Social Fractionalization, Political Instability, and the Size of Government
Annett, Anthony

Working Paper No. 00/83
VIVAT, CVAT, and All That—New Forms of Value-Added Tax for Federal Systems
Keen, Michael

Working Paper No. 00/84
Sex Discrimination and Growth
Esteve-Volart, Berta

Working Paper No. 00/85
Real Effects of High Inflation
Braumann, Benedikt

Working Paper No. 00/86
Centripetal Forces in China’s Economic Take-off
Dayal-Gulati, Anuradha; Husain, Aasim M.

Working Paper No. 00/87
Capital Mobility and the Output-Inflation Tradeoff
Loungani, Prakash; Razin, Assaf; Yuen, Chi-Wa

Working Paper No. 00/88
Spillovers Through Banking Centers—A Panel Data Analysis
van Rijckeghem, Caroline; Weder, Beatrice S.

Working Paper No. 00/89
Stock Returns and Output Growth in Emerging and Advanced Economies
Mauro, Paolo

Working Paper No. 00/90
Bank Failures and Fiscal Austerity—Policy Presecriptions for a Developing Country
Feltenstein, Andrew

Working Paper No. 00/91
Czech Koruna and Polish Zloty Currency Options—Information Contnent and EU-Accession Implications
Morales, Armando

Working Paper No. 00/92
Financial Institutions, Financial Contagion, and Financial Crises
Haizhou Huang; Chenggang Xu

Working Paper No. 00/93
The New Capital Adequacy Framework—Institutional Constraints and Incentive Structures
Karacadag, Cem; Taylor, Michael

Working Paper No. 00/94
Factor Reallocation and Growth in Developing Countries
Poirson, Helene

Working Paper No. 00/95
The Yen-Dollar Rate—Have Interventions Mattered?
Ramaswamy, Ramana; Samiei, Hossein

Working Paper No. 00/96
Aftermath of Banking Crises—Effects on Real and Monetary Variables
Gupta, Poonam

Working Paper No. 00/97
Currency Boards, Credibility, and Macroeconomic

Rivera Batiz, Luis; Sy, Amadou

Working Paper No. 00/98
Turkmenistan—The Burden of Current Agricultural

Pastor, Gonzalo; van Rooden, Ron

Working Paper No. 00/99
Real Exchange Rates and Productivity—Closed-Form Solutions and Some Empirical Evidence
Begum, Jahanara

Working Paper No. 00/100
Globalization and Catching-Up—From Recession to Growth in Transition Economies
Kolodko, Grzegorz

Working Paper No. 00/101
International Spillovers of Macroeconomic Shocks—
A Quantitative Exploration

Laxton, Douglas; Prasad, Eswar

Working Paper No. 00/102
Indonesia—Implementing National Policies in a Decentralized Context—Special Purpose Programs to Protect the Poor
Ahmad, S. Ehtisham; Leruth, Luc

Working Paper No. 00/103
Do Asset Prices in Transition Countries Contain Information About Future Economic Activity?
Christoffersen, Peter F.; Slok, Torsten

Working Paper No. 00/104
The Impact of Intersectoral Labor Reallocation on Economic Growth
Poirson, Helene

Working Paper No. 00/105
Global Financial Crises—Institutions and Incentives
Kumar, Manmohan S.; Masson, Paul R.; Miller, Marcus

IMF Working Papers and other IMF publications can be downloaded in full-text format from the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm.

World Economic Outlook, May 2000

The projections and analysis contained in the semiannual World Economic Outlook (WEO) are an integral element of the IMF’s ongoing surveillance of economic developments and policies in its member countries and of the global economic system. The country projections in the WEO are prepared by the IMF’s area departments on the basis of internationally consistent assumptions about world activity, exchange rates, and conditions in international financial and commodity markets. The May 2000 WEO discusses the ongoing improvement in the world economy since the financial market turbulence in 1997–98, but also draws attention to several growing imbalances in global activity. These include the rising external current account imbalances among the major currency areas, the apparent misalignments of several key currencies compared with medium-term fundamentals, and the very high stock market valuations around the world.

The last point is considered in more detail in one of the background analytical chapters of the May 2000 WEO, focusing on “Asset prices and the business cycle.” This chapter first discusses the main determinants of asset prices and their linkages with economic activity, and then assesses the policy implications arising from recent increases in prices and volatility in asset markets. Two main challenges for macroeconomic policy are identified: to prevent financial market excesses from spilling over to goods and services markets, thus threatening macroeconomic stability; and to minimize the risk that sustained periods of asset price inflation or deflation will undermine financial sector soundness. These considerations do not imply that targeting a certain level of asset prices should become a macroeconomic policy goal similar to inflation or monetary targeting. The chapter notes, however, that asset price movements may convey valuable information about future developments in economic activity and inflation, and that there are sound conceptual reasons and ample historical evidence in support of policies that do not always accommodate asset price movements. Policies that “lean against the wind” during cyclical upswings when asset prices appear to be rising too rapidly, or that are loosened when downswings in activity lead to a sharp drop in asset markets, may contribute to longer-term economic and financial stability.

Another background chapter, assessing “How can the poorest countries catch up?,” is motivated by the disappointing progress in raising real incomes and alleviating poverty in many developing countries, and the recent renewed emphasis on debt relief and reduction in poverty. The chapter considers, in particular, the impediments to growth in the developing countries that have failed to prosper, and the policies that could lead to better economic prospects. While there does not appear to be any single formula for kick-starting growth, experiences in the successful developing countries indicate that macroeconomic stability, sound institutional arrangements, and openness to trade are conducive to, or at least associated with, high sustainable growth. Conversely, poor education and health, ineffective governance, weak rule of law, and war often appear to be impediments to prosperity. The chapter points out that unsustainable debt burdens can also reduce incentives for growth and development. It notes, though, that debt relief (such as that available under the Heavily Indebted Poor Countries Initiative) and other international support need to be accompanied by domestic policy reforms to address the underlying causes of the initial debt buildup.

The final chapter of the May 2000 WEO provides an overview of key economic developments and policy lessons of the twentieth century. This assessment focuses on three interrelated areas—the impact of technological change, developments in the international monetary system, and the expansion in the role of the public sector. The chapter draws, in part, on two background studies, one prepared by Nicholas Crafts on “Globalization and growth in the twentieth century,” (IMF Working Paper 00/44) the other by Barry Eichengreen and Nathan Sussman on “The international monetary system in the (very) long run” (IMF Working Paper 00/43).

These background papers, together with the May 2000 WEO, are available in full-text format at the Research at the IMF website at http://www.imf.org/external/pubs/res/index.htm. The fall issue of the WEO will be available at this website on September 19, and the published version will be available in October.

Editor’s Note

The research summaries in this issue cover two areas of considerable importance in recent research and operational work at the IMF. The first concerns issues related to the IMF’s role as international lender of last resort in the context of the new global financial architecture. The second topic, a related one, is on financial contagion. As indicated by the extensive lists of references, considerable research in both areas has been done and is ongoing, and this work cuts across departments at the IMF.

In addition to the usual contents, this issue also contains a description of one of the major publications of the IMF’s Research Department: the World Economic Outlook. The main themes in the latest issue (May 2000) of this semiannual publication, and some of the background analytical material for the report, are summarized in a short article.
—Eswar Prasad

Journal Description and Subscription Request

The IMF Research Bulletin is a quarterly publication in English and is available free of cost. Material from the bulletin may be reprinted with proper attribution. Editorial correspondence may be addressed to The Editor, IMF Research Bulletin, IMF, Room 10-548, Washington, DC 20431 U.S.A. or e-mailed to resbulletin@imf.org. Subscription requests should be addressed to Publication Services, Box X2000, IMF, Washington, DC 20431 U.S.A.; e-mail: publications@imf.org.