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Welfare Implications of a Second Lender in the International Markets

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Author Info
Luis Opazo

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Abstract

The role of an extra lender in the international markets – such the IMF or another similar institution - has been widely covered in academic discussions and among policy makers. However, there is neither a clear answer nor a consensus about its welfare consequences. On the one hand, it is argued that the moral hazard consequences of an extra lender could be strong enough to offset any positive effect of an additional source of funding. On the other hand, it is argued that moral hazard consequences could be negligible and, therefore, the second lender’s presence could be welfare improving. The aim of this paper is twofold. First, it provides a numerical perspective about the welfare effect of an active second lender. Second, it sheds light on the debt dynamics in the two-lender case. The main result is that the second lender is not beneficial from a welfare standpoint for a wide range of parameters. Without coordination, the estimates imply welfare losses that range from 1.5% to 6% of GDP, depending on the severity of the second lender’s penalties. On the other hand, if a coordination mechanism is imposed, such as the second lender acting as a lender of last resort, then the model will mimic a one-lender model where the first lender is crowded out from the market. l II) could be helpful on this task.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 422.

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Date of creation: Jul 2007
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Handle: RePEc:chb:bcchwp:422

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  3. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June. [Downloadable!] (restricted)
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  5. Mark Aguiar & Gita Gopinath, 2004. "Emerging Market Business Cycles: The Cycle is the Trend," NBER Working Papers 10734, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Kenneth M. Kletzer & Brian D. Wright, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, vol. 90(3), pages 621-639, June. [Downloadable!] (restricted)
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  7. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March. [Downloadable!] (restricted)
  8. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February. [Downloadable!] (restricted)
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  9. Cristina Arellano, 2005. "Default Risk, the Real Exchange Rate and Income Fluctuations in Emerging Economies," 2005 Meeting Papers 516, Society for Economic Dynamics. [Downloadable!]
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  11. Guido Sandleris & Gaston R. Gelos & Ratna Sahay, 2004. "Sovereign Borrowing by Developing Countries: What Determines Market Access?," IMF Working Papers 04/221, International Monetary Fund.
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  12. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August. [Downloadable!] (restricted)
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