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International Financial Contagion and the IMF; A Theoretical Framework

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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.

Suggested Citation

  • Peter B. Clark & Haizhou Huang, 2001. "International Financial Contagion and the IMF; A Theoretical Framework," IMF Working Papers 01/137, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:01/137
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    References listed on IDEAS

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    14. 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.
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    Cited by:

    1. 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.
    2. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
    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. Jeronimo Zettelmeyer & Jonathan David Ostry & Olivier D Jeanne, 2008. "A Theory of International Crisis Lending and IMF Conditionality," IMF Working Papers 08/236, International Monetary Fund.

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