TY - JOUR AU - Corsetti,Giancarlo AU - Guimaraes,Bernardo AU - Roubini,Nouriel TI - International Lending of Last Resort and Moral Hazard: A Model of IMF's Catalytic Finance JF - National Bureau of Economic Research Working Paper Series VL - No. 10125 PY - 2003 Y2 - December 2003 UR - http://www.nber.org/papers/w10125 L1 - http://www.nber.org/papers/w10125.pdf N1 - Author contact info: Giancarlo Corsetti European University Institute Florence, ITALY E-Mail: giancarlo.corsetti@iue.it Bernardo V. Guimaraes London School of Economics Department of Economics Houghton Street London WC2A 2AE United Kingdom Tel: 44-20-79557502 E-Mail: b.guimaraes@lse.ac.uk Nouriel Roubini Department of Economics, KMC 7-83 Stern School of Business, New York University 44 West 4th Street New York, NY 10012 Tel: 212/998-0886 Fax: 212/995-4218 E-Mail: nroubini@stern.nyu.edu M1 - published as Corsetti, Giancarlo, Bernardo Guimaraes and Nouriel Roubini. "International Lending Of Last Resort And Moral Hazard: A Model Of IMF's Catalytic Finance," Journal of Monetary Economics, 2006, v53(3,Apr), 441-471. AB - It is often argued that the provision of liquidity by the international institutions such as the IMF to countries experiencing balance of payment problems can have catalytic effects on the behavior of international financial markets, i.e., it can reduce the scale of liquidity runs by inducing investors to roll over their financial claims to the country. Critics point out that official lending also causes moral hazard distortions: expecting to be bailed out by the IMF, debtor countries have weak incentives to implement good but costly policies, thus raising the probability of a crisis. This paper presents an analytical framework to study the trade-off between official liquidity provision and debtor moral hazard. In our model international financial crises are caused by the interaction of bad fundamentals, self-fulfilling runs and policies by three classes of optimizing agents: international investors, the local government and the IMF. We show how an international financial institution helps prevent liquidity runs via coordination of agents' expectations, by raising the number of investors willing to lend to the country for any given level of the fundamental. We show that the influence of such an institution is increasing in the size of its interventions and the precision of its information: more liquidity support and better information make agents more willing to roll over their debt and reduces the probability of a crisis. Different from the conventional view stressing debtor moral hazard, we show that official lending may actually strengthen a government incentive to implement desirable but costly policies. By worsening the expected return on these policies, destructive liquidity runs may well discourage governments from undertaking them, unless they can count on contingent liquidity assistance. ER -