Download Financial Market Structures

A Model of the IMF as a Coinsurance
Arrangement
Ralph Chami, Sunil Sharma & Ilhyock Shim
Conference on
“Dollars, Debt and Deficits—60 Years After Bretton Woods”
Banco de España, Madrid, June 14-15, 2004
Introduction
• IMF has seen a sharp increase in demand for
financial support from emerging market
countries
• Recent IMF programs have been large,
breaching “normal” access limits
• Role of the IMF—emergency lender, crisis
manager
• Analyze the dilemmas created for the IMF by its
mandate, and the incentives created for member
countries by IMF lending operations
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I. Rationale for a Coinsurance
Arrangement
• Is it mutually advantageous for countries to
coinsure each other—yes.
• Providing coinsurance creates moral hazard
• Interdependence and the mitigation of moral
hazard
• Peer monitoring
• Centralized monitoring and provision of
resources
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II. Operating the Coinsurance
Arrangement.
• Objectives
• Provide appropriate incentives to member
countries
• Should IMF precommit to a loan contract?
• Or should the loan contract be formulated
after the country falls into a crisis.
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The IMF’s Choice of Contract
• Objective Function: (i) Safeguarding its
resources; (ii) Country welfare and safeguarding
its resources.
• IMF’s information set: cannot perfectly observe
the crisis prevention and crisis resolution efforts
of member countries.
• Problem: Choose a loan contract to maximize its
objective function taking into account the
incentive effects on borrowing countries.
• Model is solved by backward induction
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IMF Objective: Safeguarding Resources
• IMF demands payment in full
• Irrespective of country effort to prevent or
resolve crises
• Country still exerts a positive effort to insure
itself optimally
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IMF Objective: Country Welfare and
Safeguarding Resources
• Trade-off
• Resources available to the IMF matter
• Issues faced by the IMF:
– Samaritan’s dilemma
– King Lear’s dilemma
– Time inconsistency
– Timing of IMF intervention matters
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Timing of Loan Contracts
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Implications for Country Policy Effort
• Under ex post loan contracts, the repayment
scheme is compensatory
• Comparison of crisis resolution efforts:
Ex ante contract > Ex post contract > “last word” contract
• Similar statement can be made for crisis
prevention efforts
• Ex ante contract involves smaller transfers
compared to the ex post contract
• Raises issue of precommitment to an ex ante
contract.
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Precommitment & Time Inconsistency
• In sequential decision problems, we have time
inconsistency problems even under complete
and perfect information
• For the IMF, this problem is exacerbated by:
– Concern for country welfare
– Information asymmetries
– Verifiability issues
• Highlights the value of precommitment
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Concluding Remarks
• Other advantages of an ex ante contract:
– Help gauge level of self-insurance needed
– Mitigate creditor moral hazard
– Self-disciplining device for the IMF
• Defining the ex ante contract—normal access
limits, loan maturity, interest rate charged,
conditionality.
• Need to address the issue of what are appropriate
country quota levels and access limits.
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