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Unconditional IMF Financial Support and Investor Moral Hazard

  • Jun Il Kim
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    This paper develops a simple model of international lending, and calibrates it to assess quantitatively the effects of contingent IMF financial support on the risk premiums and the crisis probability. In the model, the country borrows in both short and long term; market (coordination) failure triggers a liquidity run and inefficient default; and the IMF lends unconditionally under a preferred creditor status. The model shows that IMF financial support can help prevent a liquidity crisis without causing investor moral hazard by helping to remove a distortion-effectively subsidizing ex post short-term investors (who run for the exit) at the expense of long-term investors (who are locked in). The resulting equilibrium is welfare enhancing as both the country's borrowing costs and the likelihood of a crisis are lower. The calibration exercises suggest that IMF-induced investor moral hazard-which occurs if the IMF lends at a subsidized rate-is unlikely to be a concern in practice, particularly if the country's economic fundamentals are strong and short-term debt is small.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/104.

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    Length: 36
    Date of creation: 01 May 2007
    Date of revision:
    Handle: RePEc:imf:imfwpa:07/104
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    1. Uma Ramakrishnan & Juan Zalduendo, 2006. "The Role of IMF Support in Crisis Prevention," IMF Working Papers 06/75, International Monetary Fund.
    2. Hyun Shin, 2001. "Coordination Risk and the Price of Debt," Economics Series Working Papers 1999-W25, University of Oxford, Department of Economics.
    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. Stephen Morris & Hyun Song Shin, 1999. "Coordination Risk and the Price of Debt," Cowles Foundation Discussion Papers 1241R, Cowles Foundation for Research in Economics, Yale University, revised Feb 2002.
    5. Jun Il Kim, 2006. "IMF-Supported Programs and Crisis Prevention; An Analytical Framework," IMF Working Papers 06/156, International Monetary Fund.
    6. Steven B. Kamin, 2002. "Identifying the role of moral hazard in international financial markets," International Finance Discussion Papers 736, Board of Governors of the Federal Reserve System (U.S.).
    7. Axel Dreher, 2004. "Does the IMF cause moral hazard? A critical review of the evidence," International Finance 0402003, EconWPA, revised 29 Mar 2004.
    8. Michael D. Bordo & Ashoka Mody & Nienke Oomes, 2004. "Keeping Capital Flowing: The Role of the IMF," International Finance, Wiley Blackwell, vol. 7(3), pages 421-450, December.
    9. Olivier Jeanne & Jeromin Zettelmeyer, 2001. "International bailouts, moral hazard and conditionality," Economic Policy, CEPR;CES;MSH, vol. 16(33), pages 407-432, October.
    10. Giovanni Dell'Ariccia & Jeromin Zettelmeyer & Isabel Schnabel, 2002. "Moral Hazard and International Crisis Lending: A Test," IMF Working Papers 02/181, International Monetary Fund.
    11. Steven Phillips & Timothy D. Lane, 2000. "Does IMF Financing Result in Moral Hazard?," IMF Working Papers 00/168, International Monetary Fund.
    12. Nancy P. Marion & Robert P. Flood, 2006. "Getting Shut Out of the International Capital Markets; It Doesn't Take Much," IMF Working Papers 06/144, International Monetary Fund.
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