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Ex ante carrots instead of ex post sticks: two examples

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  • Aizenman, Joshua

Abstract

This paper argues that the limited ability to help developing countries in a crisis should shift the focus to policies helping in reducing the ex ante probability of crises. Indirectly, such policies would also alleviate the depths of realized crises. Two specific ideas are explored: I. International reserves escrow accounts: Managing international reserves provides an effective mechanism for self insurance. The hazard of this mechanism is that international reserves are easy prey for opportunistic policy makers in polarized countries characterized by political instability. This hazard may be alleviated by escrow accounts run by the International Financial Institutions (IFIs), where part of the international reserves of a country are saved and would be used if pre-set conditions, like large TOT deteriorations, are met. The IFIs may offer a subsidized return on these escrow accounts in order to encourage countries to reduce external borrowing and to increase fiscal savings. Such subsidies may be welfare improving due to the over borrowing bias induced by sovereign risk. II. IFIs as lenders of last resort to finance fiscal reforms: I illustrate this possibility in a modified version of Cukierman, Edwards and Tabellinis (AER 1992) model. I identify conditions where IFIs function as the lenders of last resort, financing fiscal reforms. IFIs financing may shift the equilibrium from an inefficient outcome with a low tax base and high inflation to a superior outcome, associated with a more sound tax system.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt22k9w6ck.

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Date of creation: 01 Mar 2005
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Handle: RePEc:cdl:ucscec:qt22k9w6ck

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Keywords: TOT shocks; International reserves escrow account; fiscal reform; developing countries; buffer funds;

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  1. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
  2. Joshua Aizenman & Nancy Marion, 2004. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," Economic Journal, Royal Economic Society, vol. 114(497), pages 569-591, 07.
  3. Joshua Aizenman & Stephen J. Turnovsky, 1999. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," NBER Working Papers 7004, National Bureau of Economic Research, Inc.
  4. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  5. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  6. Laibson, David, 1998. "Life-cycle consumption and hyperbolic discount functions," European Economic Review, Elsevier, vol. 42(3-5), pages 861-871, May.
  7. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, vol. 67(4), pages 539-61, October.
  8. William Easterly, 2002. "The cartel of good intentions: The problem of bureaucracy in foreign aid," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 5(4), pages 223-250.
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