I. INTRODUCTION
1. Does the availability of financial support from the IMF give rise to moral hazard? In other words, does the presence of the IMF, as an institution that lends to countries in crisis, create incentives for borrowers and lenders to behave in ways that makes a crisis more likely?2 The view that it does has become increasingly prevalent in the wake of recent crises, notably in Mexico and Asia. Concerns over moral hazard have had an important role in recent discussions of “international financial architecture”, the role of the Fund, and the need for involving (bailing in) the private sector in resolving financial crises.3
2. It is inherently plausible that financing from the IMF generates some element of moral hazard. If the consequences of a financial crisis would be more dire if the Fund’s support were not available—with even sharper exchange rate depreciation and inflation, greater asset price declines, and in some cases default—it seems inevitable that the availability of Fund support would dull both countries’ incentives to take preventive action to avoid a crisis and lenders’ incentives to exercise prudence. The presence of the Fund would thus encourage borrowers and lenders to take some risks that they would not otherwise have taken. But that is not necessarily a problem: on the contrary, it could reflect the Fund’s success in alleviating uncertainties associated with trade and financial relations across national borders.4 The key questions are whether the availability of Fund support encourages imprudent risks to be taken and whether these additional risks outweigh the benefit of the Fund’s financial assistance in attenuating the costs of the crisis. Addressing these questions would in turn hinge in turn on a prior empirical question: how important is any moral hazard created by the Fund in influencing borrowing countries’ and lenders’ behavior before a crisis?
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3. Given the prominence of moral hazard in policy discussions—and the certainty with which its importance, or lack thereof, is often asserted5—it is surprising that there has been so little research investigating its empirical relevance.6 While it is difficult to test for the existence of moral hazard directly, the hypothesis that moral hazard is important does have some implications that can be examined in relation to evidence. This paper examines some preliminary evidence regarding these implications.
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4. The remainder of the paper is structured as follows. Section II discusses the concept of moral hazard in relation to IMF lending. Section III examines some empirical implications of moral hazard, based on the reactions of financial markets to events that may convey information regarding the availability of IMF financing. Section IV examines the scale of IMF disbursements, asking whether it seems sufficient to guarantee international lending. Section V presents some further discussion and conclusions.
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Category: Finance
