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IMF Coinsurance Model for Crisis Management

This paper explores a model proposing a coinsurance arrangement for the IMF to manage crises, analyzing incentives, and dilemmas faced by the IMF and member countries in lending operations. It discusses the rationale, operation, objectives, and implications of such an arrangement, considering the timing of loan contracts and precommitment issues to maximize outcomes for both parties. The model highlights the value of precommitment in addressing time inconsistency problems and offers insights into crisis prevention and resolution efforts.

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IMF Coinsurance Model for Crisis Management

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  1. A Model of the IMF as a Coinsurance Arrangement Ralph Chami, Sunil Sharma & Ilhyock Shim Conference on “Dollars, Debt and Deficits—60 Years After Bretton Woods” Banco de España, Madrid, June 14-15, 2004

  2. Introduction • IMF has seen a sharp increase in demand for financial support from emerging market countries • Recent IMF programs have been large, breaching “normal” access limits • Role of the IMF—emergency lender, crisis manager • Analyze the dilemmas created for the IMF by its mandate, and the incentives created for member countries by IMF lending operations

  3. I. Rationale for a Coinsurance Arrangement • Is it mutually advantageous for countries to coinsure each other—yes. • Providing coinsurance creates moral hazard • Interdependence and the mitigation of moral hazard • Peer monitoring • Centralized monitoring and provision of resources

  4. II. Operating the Coinsurance Arrangement. • Objectives • Provide appropriate incentives to member countries • Should IMF precommit to a loan contract? • Or should the loan contract be formulated after the country falls into a crisis.

  5. The IMF’s Choice of Contract • Objective Function: (i) Safeguarding its resources; (ii) Country welfare and safeguarding its resources. • IMF’s information set: cannot perfectly observe the crisis prevention and crisis resolution efforts of member countries. • Problem: Choose a loan contract to maximize its objective function taking into account the incentive effects on borrowing countries. • Model is solved by backward induction

  6. IMF Objective: Safeguarding Resources • IMF demands payment in full • Irrespective of country effort to prevent or resolve crises • Country still exerts a positive effort to insure itself optimally

  7. IMF Objective: Country Welfare and Safeguarding Resources • Trade-off • Resources available to the IMF matter • Issues faced by the IMF: • Samaritan’s dilemma • King Lear’s dilemma • Time inconsistency • Timing of IMF intervention matters

  8. Timing of Loan Contracts

  9. Implications for Country Policy Effort • Under ex post loan contracts, the repayment scheme is compensatory • Comparison of crisis resolution efforts: Ex ante contract > Ex post contract > “last word” contract • Similar statement can be made for crisis prevention efforts • Ex ante contract involves smaller transfers compared to the ex post contract • Raises issue of precommitment to an ex ante contract.

  10. Precommitment & Time Inconsistency • In sequential decision problems, we have time inconsistency problems even under complete and perfect information • For the IMF, this problem is exacerbated by: • Concern for country welfare • Information asymmetries • Verifiability issues • Highlights the value of precommitment

  11. Concluding Remarks • Other advantages of an ex ante contract: • Help gauge level of self-insurance needed • Mitigate creditor moral hazard • Self-disciplining device for the IMF • Defining the ex ante contract—normal access limits, loan maturity, interest rate charged, conditionality. • Need to address the issue of what are appropriate country quota levels and access limits.

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