IMF Conditionality

This paper presents a principal-agent model of IMF conditional lending, in the aftermath of a “capital-account” liquidity crisis. We show that traditional ex-post conditionality can be e¤ective in safeguarding the Fund’s resources, allowing for the provision of e¢cient emergency lending and reducing ine¢cient ex-ante credit rationing if the capital out‡ow which triggers the crisis is not excessive. We apply the baseline model to analyse the issues of debtor moral hazard and private sector involvement (PSI), which have characterised the recent debate on reforming the International Financial Architecture. We show that debtor moral hazard is only a concern if the IMF cannot commit to make the post-crisis participation constraint of the debtor country binding, and that it can only be resolved via ex-ante conditionality (or pre-quali...cation). Attempts to reduce debtor moral hazard may however compromise the Fund’s ability to safeguard its resources ex-post. We also show that PSI in the solution of balance of payments crisis is a central determinant of the e¤ectiveness of both crisis prevention and resolution e¤orts on the part of the IMF. PSI may be an enabling condition for e¢cient crisis resolution, and may therefore be imposed even by a “PSI-averse” IMF. Moreover, there are conditions under which it is optimal for the IMF to ex-ante precommit to a tough, and ex-post sub-optimal, PSI policy, in order to mitigate investor moral hazard. JEL Classi...cation: F33, F34.