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International Financial Contagion and the Fund

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  • Peter B. Clark
  • Haizhou Huang

Abstract

We provide a model of contagion where countries borrow or lend for consumption smoothing at the market interest rate or a lower IMF rate. Highly indebted countries hit by large negative shocks to output will default. The resulting reduction in loanable funds raises interest rates, increases the vulnerability of other indebted countries, and can generate further rounds of defaults. In this environment the IMF can limit default and internalize the externality generated by contagion through its lending with conditionality. We characterize the IMF''s optimal lending decision in mitigating the loss in world consumption.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/137.

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Length: 31
Date of creation: 01 Sep 2001
Date of revision:
Handle: RePEc:imf:imfwpa:01/137

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Related research

Keywords: Conditionality; IMF; contagion; capital market; financial contagion; international capital; capital markets; international financial contagion; international capital market; moral hazard; international capital markets; financial crises; capital flows; private capital; private capital flows; financial crisis; world capital market; debt service; private financing; debt servicing; private capital markets; liquidity crisis; capital inflows; private capital market; international financial crises; international capital flows; international crisis; world capital markets; pre-crisis; international financial crisis; capital controls; current account deficits; deposit insurance; floating exchange rate system; bank runs; debt service payments; international crisis lending; asian crisis; global financial crises; crisis lending; currency crises;

References

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  1. Morris Goldstein & Michael Mussa, 1993. "The Integration of World Capital Markets," IMF Working Papers 93/95, International Monetary Fund.
  2. International Monetary Fund, 1998. "Do IMF-Supported Programs Work? a Survey of the Cross-Country Empirical Evidence," IMF Working Papers 98/169, International Monetary Fund.
  3. Michael Mussa, 1999. "Reforming the International Financial Architecture: Limiting Moral Hazard and Containing Real Hazard," RBA Annual Conference Volume, in: David Gruen & Luke Gower (ed.), Capital Flows and the International Financial System Reserve Bank of Australia.
  4. Marcus H. Miller & Lei Zhang, 1999. "Sovereign Liquidity Crisis: The Strategic Case for A Payments Standstill," Working Paper Series WP99-8, Peterson Institute for International Economics.
  5. Haizhou Huang & Chenggang Xu, 1999. "Financial Institutions, Financial Contagion, and Financial Crises," CID Working Papers 21, Center for International Development at Harvard University.
  6. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 403-14, July.
  8. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Marchesi, Silvia & Thomas, Jonathan P, 1999. "IMF Conditionality as a Screening Device," Economic Journal, Royal Economic Society, vol. 109(454), pages C111-25, March.
  10. Manmohan S. Kumar & Paul R. Masson & Marcus Miller, 2000. "Global Financial Crises," IMF Working Papers 00/105, International Monetary Fund.
  11. Paul Masson, 1999. "Multiple equilibria, contagion, and the emerging market crises," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  12. Haizhou Huang & Charles Goodhart, 1999. "A Simple Model of an International Lender of Last Resort," FMG Discussion Papers dp336, Financial Markets Group.
  13. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  14. Olivier Jeanne & Jeromin Zettelmeyer, 2001. "International bailouts, moral hazard and conditionality," Economic Policy, CEPR & CES & MSH, vol. 16(33), pages 407-432, October.
  15. Brian D. Wright & Kenneth M. Kletzer, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, vol. 90(3), pages 621-639, June.
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Citations

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Cited by:
  1. Jeanne, Olivier & Ostry, Jonathan D & Zettelmeyer, Jeronimo, 2008. "A Theory of International Crisis Lending and IMF Conditionality," CEPR Discussion Papers 7022, C.E.P.R. Discussion Papers.
  2. Weithoner, Thomas, 2006. "How can IMF policy eliminate country moral hazard and account for externalities?," Journal of International Money and Finance, Elsevier, vol. 25(8), pages 1257-1276, December.
  3. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
  4. Peter Clark & Haizhou Huang, 2006. "International Financial Contagion and the Fund —A Theoretical Framework," Open Economies Review, Springer, vol. 17(4), pages 399-422, December.

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