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IMF Conditionality

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    Abstract

    This paper presents a principal-agent model of IMF conditional lending, in the aftermath of a "capital-account" liquidity crisis. We show that traditional ex-post conditonality can be effective in safeguarding the Fund's resources, allowing for the provision of efficient emergency lending and reducing inefficient ex-ante credit rationing if the capital outflow which triggers the crisis is not excessive. We apply the baseline model to analyse the issues of debtor moral hazard and private sector involement (PSI), which have characterised the recent debate on reforming the International Financial Architecture. We show that debtor moral hazard is only a concern if the IMF cannot commit to make the post-crisis participation constraint of the debtor country binding, and that it can only be resolved via ex-ante conditionality (or pre-qualification). Attempts to reduce debtor moral hazard may however compromise the Fund's ability to safeguard its resources ex-post. We also show that PSI in the solution of balance of payments crisis is a central determinant of the effectiveness of both crisis prevention and resolution efforts on the part of the IMF. PSI may be an enabling condition for efficient crisis resolution, and may therefore be imposed even by a "PSI-averse" IMF. Moreover, there are conditions under which it is optimal for the IMF to ex-ante precommit to a tough, and ex-post sup-optimal, PSI policy,in order to mitigate investor moral hazard.

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    File URL: http://www.nuff.ox.ac.uk/Economics/papers/2001/w19/IMFConditionalitySept2001.pdf
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    Bibliographic Info

    Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2001-W19.

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    Length: 51 pages
    Date of creation: 01 Feb 2001
    Date of revision: 01 Sep 2001
    Handle: RePEc:nuf:econwp:0119

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    Web page: http://www.nuff.ox.ac.uk/economics/

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    Keywords: IMF; conditionality; balance of payments crisis.;

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    1. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
    2. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
    3. Steven Phillips & Timothy D. Lane, 2000. "Does IMF Financing Result in Moral Hazard?," IMF Working Papers 00/168, International Monetary Fund.
    4. Morris Goldstein, 2000. "Strengthening the International Financial Architecture: Where Do We Stand?," Working Paper Series WP00-8, Peterson Institute for International Economics.
    5. John Williamson, 2000. "The Role of the IMF: A Guide to the Reports," Policy Briefs PB00-5, Peterson Institute for International Economics.
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    8. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
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    10. Louis Dicks-Mireaux & Miguel A. Savastano & Adam Bennett & María Vicenta Carkovic S. & Mauro Mecagni & James John & Susan Schadler, 1995. "IMF Conditionality: Experience Under Stand-by and Extended Arrangements, Part I: Key Issues and Findings," IMF Occasional Papers 128, International Monetary Fund.
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    12. Diwan, I. & Rodrik, D., 1992. "External Debt, Adjustment, and Burden Sharing: A Unified Framework," Princeton Studies in International Economics 73, International Economics Section, Departement of Economics Princeton University,.
    13. Boughton, James M, 2000. "From Suez to Tequila: The IMF as Crisis Manager," Economic Journal, Royal Economic Society, vol. 110(460), pages 273-91, January.
    14. Jeffrey D. Sachs, 1989. "Conditionality, Debt Relief, and the Developing Country Debt Crisis," NBER Chapters, in: Developing Country Debt and the World Economy, pages 275-284 National Bureau of Economic Research, Inc.
    15. Jeanne, Olivier, 2000. "Foreign currency debt and the global financial architecture," European Economic Review, Elsevier, vol. 44(4-6), pages 719-727, May.
    16. Claessens, Stijn & Diwan, Ishac, 1990. "Investment Incentives: New Money, Debt Relief, and the Critical Role of Conditionality in the Debt Crisis," World Bank Economic Review, World Bank Group, vol. 4(1), pages 21-41, January.
    17. Marchesi, Silvia & Thomas, Jonathan P, 1999. "IMF Conditionality as a Screening Device," Economic Journal, Royal Economic Society, vol. 109(454), pages C111-25, March.
    18. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
    19. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
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    Cited by:
    1. Axel Dreher, 2008. "IMF Conditionality: Theory and Evidence," KOF Working papers 08-188, KOF Swiss Economic Institute, ETH Zurich.
    2. Prasanna Gai & Nicholas Vause, 2003. "Sovereign debt workouts with the IMF as delegated monitor - a common agency approach," Bank of England working papers 187, Bank of England.
    3. 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.
    4. Drazen, Allan, 2002. "Conditionality and Ownership in IMF Lending: A Political Economy Approach," CEPR Discussion Papers 3562, C.E.P.R. Discussion Papers.
    5. Adrian Penalver, 2004. "How can the IMF catalyse private capital flows? A model," Bank of England working papers 215, Bank of England.

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