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International Financial Contagion and the IMF: A Theoretical Framework
Author:
Mr. Peter B. Clark
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and
Mr. Haizhou Huang
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Series:
IMF Working Papers
Volume/Issue:
Volume 2001: Issue 137
Language:
English
Publication Date:
01 Sep 2001
DOI:
https://doi.org/10.5089/9781451855913.001
ISBN:
9781451855913
ISSN:
1018-5941
Pages:
31
Keywords:
WP; international financial contagion; conditionality; IMF; equilibrium interest rate; world interest rate; IMF charge; loanable funds; interest rate increase; loan volume; fund conditionality; IMF subsidy; world capital market; Consumption; International capital markets; Loans; Financial contagion; Moral hazard
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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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.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund