If interest rates (country spreads) rise, debt can rapidly be subject to a snowball effect, which then becomes self-fulfilling with regard to the fundamentals themselves. This is a market imperfection, because we cannot be confident that the unaided market will choose the good equilibrium' over the bad equilibrium'. We see here a fundamental flaw in the process of market discipline. We propose a policy intervention to deal with this structural weakness in the mechanisms of international capital flows. This is based on a simple taxonomy that enables us to break down the origin of crises into three components: a crisis of confidence (spreads and currency crisis), a crisis of fundamentals (real growth rate), and a crisis of economic policy (primary deficit). The policy would seek to short-circuit confidence crises, partly by using IMF support to improve ex ante incentives.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
10533.
Length: Date of creation: May 2004 Date of revision: Handle: RePEc:nbr:nberwo:10533
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Find related papers by JEL classification: F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions F34 - International Economics - - International Finance - - - International Lending and Debt Problems
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Peter H. Lindert & Peter J. Morton, 1989.
"How Sovereign Debt Has Worked,"
NBER Chapters,
in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages 39-106
National Bureau of Economic Research, Inc.
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Peter H. Lindert & Peter J. Morton, 1989.
"How Sovereign Debt Has Worked,"
NBER Chapters,
in: Developing Country Debt and the World Economy, pages 225-236
National Bureau of Economic Research, Inc.
[Downloadable!]
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