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The efficient resolution of capital account crises: how to avoid moral hazard

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  • Gregor Irwin

    (Bank of England, UK)

  • David Vines

    (University of Oxford, UK, Australian National University and CEPR)

Abstract

This paper presents a model of capital account crises and uses it to study resolution mechanisms for both liquidity and solvency crises. It shows that liquidity crises should be dealt with by a standstill combined with IMF lending into arrears, whereas solvency crises should be resolved by debt write-downs. Dealing with solvency crises by lending would require a subsidy and this creates moral hazard, such as incentives for excessive borrowing, for too little equity financing and for investment in projects that are inefficient. The analysis underlines the importance of accurately assessing whether a crisis is rooted in a liquidity or a solvency problem. Copyright © 2005 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.270
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 10 (2005)
Issue (Month): 3 ()
Pages: 233-250

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Handle: RePEc:ijf:ijfiec:v:10:y:2005:i:3:p:233-250

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  1. Dimitrios Tsomocos, 2003. "Equilibrium analysis, banking, contagion and financial fragility," FMG Discussion Papers dp450, Financial Markets Group.
  2. Andrew G Haldane & Gregor Irwin & Victoria Saporta, 2004. "Bail out or work out? Theoretical considerations," Bank of England working papers 219, Bank of England.
  3. Andrew G Haldane & Jorg Scheibe, 2004. "IMF lending and creditor moral hazard," Bank of England working papers 216, Bank of England.
  4. Geanakoplos, J. D. & Tsomocos, D. P., 2002. "International finance in general equilibrium," Research in Economics, Elsevier, vol. 56(1), pages 85-142, June.
  5. Olivier Jeanne & Jeromin Zettelmeyer, 2001. "International Bailouts, Moral Hazard, and Conditionality," CESifo Working Paper Series 563, CESifo Group Munich.
  6. Prasanna Gai & Ashley Taylor, 2004. "International financial rescues and debtor country moral hazard," Money Macro and Finance (MMF) Research Group Conference 2003 34, Money Macro and Finance Research Group.
  7. Giovanni Dell'Ariccia & Jeromin Zettelmeyer & Isabel Schnabel, 2002. "Moral Hazard and International Crisis Lending: A Test," IMF Working Papers 02/181, International Monetary Fund.
  8. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall.
  9. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
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Cited by:
  1. Philipp Maier, 2007. "Do We Need the IMF to Resolve a Crisis? Lessons from Past Episodes of Debt Restructuring," Working Papers 07-10, Bank of Canada.

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