13 - Countries in payments' difficulties: what can the IMF do?

Summary

Introduction

There are several different strands in the current economic literature regarding the role of IMF. In this chapter, I develop one particular theme, namely the role of the IMF in assisting countries that have serious international payments difficulties. One characterisation of this debate is that between the ‘moral hazard’ school and the ‘liquidity’ school. The former stresses the classic perverse incentive problem created with insurance-type interventions in capital markets leading lenders to bet on being ‘bailed out’ at some future date if things go wrong – especially in countries that might be considered ‘too big to fail’.

Adherents to this school point to the sheer size of IMF-led packages to emerging economies, the very low emerging-market spreads after the assistance to Mexico in 1995 and the ‘lending boom’ to emerging economies, including the Asian economies, that then followed as evidence of the potential importance of moral hazard. In figure 13.1, we plot the EMBI spread from 1994 as an illustration.

Some have labelled this as a ‘theory of plenty’: a theory of too much private lending, on the one hand, and too little discipline on the other. This lack of discipline might result in countries contracting large amounts of debt (either in the public or private sectors or in the private sector with implicit or explicit guarantees) while, at the same time, failing to address structural weaknesses or not adjusting quickly enough to negative shocks as they arise.