Toward a Lender of First Resort

March 1, 2006

Preview Citation

Format: Chicago

Daniel Cohen, and Richard Portes. Toward a Lender of First Resort, (USA: International Monetary Fund, 2006) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

If interest rates (country spreads) rise, debt can rapidly be subject to a snowball effect, which becomes self-fulfilling with regard to the fundamentals themselves. This is a market imperfection, because we cannot be confident that the unaided market will choose the "good" over the "bad" equilibrium. We propose a policy intervention to deal with this structural weakness in the mechanisms of international capital flows. This is based on a simple taxonomy that breaks down the origin of crises into three components: confidence (spreads and currency crisis), fundamentals (real growth rate), and economic policy (primary deficit). Theory then suggests a set of circumstances in which a lender of first resort would be desirable. The policy would seek to short-circuit confidence crises, partly by using IMF support to improve ex ante incentives. Theory also illuminates the potential role of collective action clauses in reducing the risk of self-fulfilling debt crises.

Subject: Debt burden, Debt default, Debt sustainability analysis, Financial crises, Public debt

Keywords: Debt crisis, Debt restructuring, Lender of last resort, Risk premium, Riskless rate, WP

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/066
Stock No:

WPIEA2006066
ISBN:

9781451863260
ISSN:

1018-5941

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