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Welfare Implications of a Second Lender in the International Markets

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  • Luis Opazo

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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  1. Stephen Morris & Hyun Song Shin, 2004. "Catalytic Finance: When Does It Work?," Yale School of Management Working Papers ysm339, Yale School of Management.
  2. 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.
  3. Kenneth M. Kletzer and Brian D. Wright., 1998. "Sovereign Debt as Intertemporal Barter," Center for International and Development Economics Research (CIDER) Working Papers C98-100, University of California at Berkeley.
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  5. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  6. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates and the current account," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  7. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  8. Dirk Krueger & Harald Uhlig, 2005. "Competitive Risk Sharing Contracts with One-Sided Commitment," SFB 649 Discussion Papers SFB649DP2005-003, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  9. William R. Zame, 1992. "Efficiency and the Role of Default When Security Markets are Incomplete," UCLA Economics Working Papers 673, UCLA Department of Economics.
  10. Rose, Andrew K., 2005. "One reason countries pay their debts: renegotiation and international trade," Journal of Development Economics, Elsevier, vol. 77(1), pages 189-206, June.
  11. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  12. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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