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Ex Ante Carrots instead of Ex Post Sticks: Two Examples

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  • Joshua Aizenman

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11242.

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Date of creation: Apr 2005
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Publication status: published as Aizenman, Joshua. “Ex ante carrots instead of ex post sticks: two examples." The Journal of the Korean Economy (Fall 2005): 131-159.
Handle: RePEc:nbr:nberwo:11242

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  1. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, American Economic Association, vol. 82(3), pages 537-55, June.
  2. Joshua Aizenman & Stephen Turnovsky, 1999. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Working Papers, University of Washington, Department of Economics 0044, University of Washington, Department of Economics.
  3. William Easterly, 2002. "The cartel of good intentions: The problem of bureaucracy in foreign aid," Journal of Economic Policy Reform, Taylor & Francis Journals, Taylor & Francis Journals, vol. 5(4), pages 223-250.
  4. Joshua Aizenman & Nancy P. Marion, 2002. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," NBER Working Papers 9154, National Bureau of Economic Research, Inc.
  5. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report, Federal Reserve Bank of Minneapolis 45, Federal Reserve Bank of Minneapolis.
  6. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  7. Laibson, David, 1998. "Life-cycle consumption and hyperbolic discount functions," European Economic Review, Elsevier, Elsevier, vol. 42(3-5), pages 861-871, May.
  8. 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, University of Chicago Press, vol. 67(4), pages 539-61, October.
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