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IMF; Brookings Institution and IMF; and University of Warwick and CEPR respectively. The authors are grateful to Mark Allen, Stanley Fischer, Olivier Jeanne, Michael Mussa and Alexander Swoboda for discussion or comments. The paper was written when Marcus Miller was Visiting Scholar at the IMF, and he is grateful for the hospitality of the Research Department. This is a revised and expanded version of the paper to be presented at the Royal Economic Society Meetings in July.
He also suggested that the IMF should focus on assessing “whether countries are likely to run into trouble” and do more to “collect and share financial information” than provide actual funding.
For a discussion of some of the conceptual issues relating to sovereign insolvency, see Guidotti and Kumar (1991).
This feature can best be justified in a two-period model in which early liquidation by the creditors reduces the return on the investment. We appeal to such a mechanism, even though our model is not explicitly multiperiod.
Although the creditor, as the residual beneficiary of pay-offs in the bad state, suffers losses from withdrawing short debt, there are benefits coming from the incentives on the debtor.
The same applies to the proposal of Buiter and Sibert (1998) that all international lending contracts include a Universal Debt Roll Over Provision, While such a provision would eliminate the unnecessary, sunspot induced runs, it would also prevent liquidity withdrawals that involve monitoring borrowers, punishing them for having adopted policies that led to the bad state.
Note that most of the East Asian countries recently hit with crisis would not have satisfied the pre-qualification criteria of the Meltzer commission.
This is analogous to the term measuring the disutility of Fund programs appearing in Marchesi and Thomas’s (1999) screening model.
In the example where the private sector did the monitoring using short term debt, the private sector was already bailed-in, provided the return Β in the bad state was substantially below D,
Banks are corporates, but given the highly leveraged positions they have relative to their equity, the mismatch in maturity between their assets and liabilities, and potential moral hazard considerations, they are in a special category.
Rogoff (1999, pp. 36) argues that “The main problem with the present system is that contains strong biases towards debt finance, especially towards intermediation by banks and does not adequately support equity finance and direct investment.”
This analysis draws on Miller and Zhang (2000).
It is implausible that legal proceedings would involve constant recontracting as long as the debtor is insolvent (as in Bulow/Rogoff): this would be very costly.
For convenience we have assumed that resulting write-down matches the percentage shown for the Paris Club. This is diagrammatically convenient, but not necessary: it is not clear that Paris Club uses a splitting rule.