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International Financial Contagion and the Fund —A Theoretical Framework

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  • Peter Clark
  • Haizhou Huang

    ()

Abstract

In this paper we provide a model of contagion in which countries are linked through the international capital market which allows borrowing and lending for consumption smoothing. Borrowing from the International Monetary Fund also provides a mechanism for countries to smooth consumption intertemporally. Facing a large shock that makes it impossible for a country simultaneously to achieve a desired minimum level of consumption and to service its foreign debt, the country will default. This will put some upward pressure on world interest rates, which raises the debt service costs of other indebted countries and can generate further rounds of defaults. In this environment the Fund has an important systemic function in lending to members to limit the extent of contagion and default. The Fund can be seen as internalizing the externality generated by the contagion that spreads through the channel of the world capital market that links all countries. Copyright Springer Science + Business Media, LLC 2006

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File URL: http://hdl.handle.net/10.1007/s11079-006-0356-8
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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 17 (2006)
Issue (Month): 4 (December)
Pages: 399-422

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Handle: RePEc:kap:openec:v:17:y:2006:i:4:p:399-422

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: International financial contagion; conditionality; IMF;

References

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  1. Peter B. Clark & Haizhou Huang, 2001. "International Financial Contagion and the Fund," IMF Working Papers 01/137, International Monetary Fund.
  2. Marchesi, Silvia & Thomas, Jonathan P, 1999. "IMF Conditionality as a Screening Device," Economic Journal, Royal Economic Society, vol. 109(454), pages C111-25, March.
  3. Haizhou Huang, 2000. "Financial Institutions, Financial Contagion, and Financial Crises," Econometric Society World Congress 2000 Contributed Papers 1595, Econometric Society.
  4. Kenneth M. Kletzer & Brian D. Wright, 2000. "Sovereign Debt as Intertemporal Barter," International Finance 0003004, EconWPA.
  5. Franklin Allen & Douglas Gale, 2000. "Financial Contagion," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 1-33, February.
  6. Manmohan S. Kumar & Paul R. Masson & Marcus Miller, 2000. "Global Financial Crises," IMF Working Papers 00/105, International Monetary Fund.
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Cited by:
  1. Inci, A. Can & Li, H.C. & McCarthy, Joseph, 2011. "Financial contagion: A local correlation analysis," Research in International Business and Finance, Elsevier, vol. 25(1), pages 11-25, January.

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