Skip to main content
SpringerLink
Log in

IMF conditionalities, liquidity provision, and incentives for fiscal adjustment

  • Published:
International Tax and Public Finance Aims and scope Submit manuscript

Abstract

This paper proposes a model to study how conditional lending and immediate liquidity provision affect incentives for fiscal adjustment in a country facing the risk of sovereign default. Conditional lending provides explicit incentives for fiscal adjustment but immediate liquidity provision is more effective in reducing liquidation costs. For some parameters, immediate liquidity provision induces fiscal adjustment and debt repayment, while conditional lending does not (and vice-versa). Incentives for fiscal adjustment are concave in the fraction of lending provided under conditionalities. A large cost of tight fiscal policy shifts the balance toward immediate liquidity provision.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2

Similar content being viewed by others

Notes

  1. A description of all types of credit lines granted by the IMF can be found at www.imf.org.

  2. Exceptions include Cuadra et al. (2010), who study cyclicality of fiscal policy in this framework, and Gonçalves and Guimaraes (2013), who shows that fiscal policy is time inconsistent in this environment.

  3. In most of the literature, creditors are risk neutral, so the domestic economy can always borrow at the actuarially fair price. Lizarazo (2013) considers the case with risk averse lenders, which generates a risk premium in the model.

  4. See Panizza et al. (2009) for a survey of this literature. The costs of sovereign default might stem from a reduction in international trade, perhaps owing to trade sanctions (see, e.g., Rose (2005) and Martinez and Sandleris (2011); reputational costs that affect access to finance or the country’s position when negotiating with other nations (see, e.g., Tomz (2007) and Fuentes and Saravia (2010); domestic problems caused by the redistribution of wealth resulting from the sovereign default (see, e.g., Broner and Ventura (2011); among others.

  5. Section 3.3 considers the case where taxes have a negative effect on output.

  6. That is as in Cuadra et al. (2010) and Gonçalves and Guimaraes (2013).

  7. Caballero and Krishnamurthy (2001) model liquidity needs in a similar way.

  8. Mishkin (1999) adds that “an important historical feature of successful lender-of-last-resort operations, is that the faster the lending is done, the lower is the amount that actually has to be lent.”

  9. There is no uncertainty in the model, so more detailed IMF preferences would not affect the results. In equilibrium, the IMF knows whether the country will choose to repay its debts or not (conditional on the IMF’s own choices). We thus assume that the IMF wants to avoid a debt default, and then study whether immediate liquidity provision or conditional lending are more effective in providing incentives for fiscal adjustment and repayment.

  10. If \(D\) happened to be larger than \(\Gamma \), then the government would choose to default, and there is nothing that the IMF could do about it. This is a case where it is never optimal to repay the contracted amount of debt.

  11. Fafchamps (1996) analyzes conditionalities that increase the cost of defaulting (\(\Gamma \) in this model). For example, trade openness might increase the potential costs from trade sanctions. In that kind of model, ex-post conditionalities might be an optimal response to larger debt, but fiscal conditionalities play a different role.

  12. The remaining parameters are: \(Y=7.68\), \(\ell _{2}=1.4\), \(\phi _{1}=2.56\), \(\phi _{2}=1.6\) and \(\Gamma =3\).

    Fig. 1
    figure 1

    Conditional lending provides more incentives for adjustment

    Full size image

  13. For \(\ell _{1}=0.997\), incentives for repayment with \(\lambda =0\) and \(\lambda =1\) are exactly the same, in the sense that the respective thresholds for the level of debt \(D\) consistent with repayment coincide.

  14. See also the discussion in Fischer (2004) and Conway (2006).

  15. In fact, a capital account position dominated by private flows is one of the criteria mentioned by the IMF for access to a flexible credit line: http://www.imf.org/external/np/exr/faq/facfaqs.htm#q6.

  16. Recent contributions include Nooruddin and Simmons (2006), Dreher and Jensen (2007) and Stone (2008).

References

  • Bird, G. (2007). The IMF: A Bird’s eye view of its role and operation. Journal of Economic Surveys, 21, 683–745.

    Article  Google Scholar 

  • Broner, F., & Ventura, J. (2011). Globalization and risk sharing. Review of Economic Studies, 78, 49–82.

    Article  Google Scholar 

  • Caballero, R., & Krishnamurthy, A. (2001). International and domestic collateral constraints in a model of emerging market crises. Journal of Monetary Economics, 48, 513–548.

    Article  Google Scholar 

  • Calvo, G. (1998). Capital flows and capital-market crises: The simple economics of sudden stops. Journal of Applied Economics, 1, 35–54.

    Google Scholar 

  • Collier, P., Guillaumont, P., Guillaumont, S., & Gunning, J. W. (1997). Redesigning conditionality? World Development, 25, 1399–1407.

    Article  Google Scholar 

  • Conway, P. (2006). The International Monetary Fund in a time of crisis: A review of Stanley Fischer’s IMF Essays from a Time of Crisis. Journal of Economic Literature, 44, 115–144.

    Article  Google Scholar 

  • Corsetti, G., Guimaraes, B., & Roubini, N. (2006). International lending of last resort and moral hazard: A model of IMF’s catalytic finance. Journal of Monetary Economics, 53, 441–471.

    Article  Google Scholar 

  • Cuadra, G., Sanchez, J. M., & Sapriza, H. (2010). Fiscal policy and default risk in emerging markets. Review of Economic Dynamics, 13, 452–469.

    Article  Google Scholar 

  • Dreher, A. (2009). IMF conditionality: Theory and evidence. Public Choice, 141, 233–267.

    Article  Google Scholar 

  • Dreher, A., & Jensen, N. (2007). Independent actor or agent? An Empirical Analysis of the Impact of US International Monetary Fund Conditions. Journal of Law and Economics, 50, 105–124.

    Article  Google Scholar 

  • Easterly, W. (2005). What did structural adjustment adjust? Policies and growth with repeated IMF and World Bank adjustment loans. Journal of Development Economics, 76, 1–22.

    Google Scholar 

  • Eaton, J., & Gersovitz, M. (1981). Debt with potential repudiation: Theoretical and empirical analysis. Review of Economic Studies, 48, 289–309.

    Article  Google Scholar 

  • Fafchamps, M. (1996). Sovereign debt, structural adjustment, and conditionality. Journal of Development Economics, 50, 313–335.

    Article  Google Scholar 

  • Fischer, S. (1999). On the Need for an International Lender of Last Resort. Journal of Economic Perspectives, 13, 85–104.

    Article  Google Scholar 

  • Fischer, S. (2004). IMF essays from a time of crisis: The international financial system, stabilization and development. Cambridge, MA: MIT Press.

    Google Scholar 

  • Fuentes, M., & Saravia, D. (2010). Sovereign defaulters: Do international capital markets punish them? Journal of Development Economics, 91, 336–347.

    Article  Google Scholar 

  • Gonçalves, C. E., & Guimaraes, B. (2013). Sovereign default risk and commitment for fiscal adjustment. Working Paper.

  • Lizarazo, S. (2013). Default risk and risk averse international investors. Journal of International Economics, 89, 317–330.

    Article  Google Scholar 

  • Martinez, J., & Sandleris, G. (2011). Is it punishment? Sovereign defaults and the decline in trade. Journal of International Money and Finance, 30, 909–930.

    Article  Google Scholar 

  • Mishkin, F. (1999). Lessons from the Asian crisis. Journal of International Money and Finance, 18, 709–723.

    Article  Google Scholar 

  • Morris, S., & Shin, H. (2006). Catalytic finance: When does it work? Journal of International Economics, 70, 161–177.

    Article  Google Scholar 

  • Nooruddin, I., & Simmons, J. W. (2006). The politics of hard choices: IMF programs and government spending. International Organization, 60, 1001–1033.

    Article  Google Scholar 

  • Panizza, U., Sturzenegger, F., & Zettelmeyer, J. (2009). The economics and law of sovereign debt and default. Journal of Economic Literature, 47, 651–698.

    Article  Google Scholar 

  • Rochet, J.-C., & Vives, X. (2004). Coordination failures and the lender of last resort: Was Bagehot right after all? Journal of the European Economic Association, 2, 1116–1147.

    Article  Google Scholar 

  • Rose, A. (2005). One reason countries pay their debts: Renegotiation and international trade. Journal of Development Economics, 77, 189–206.

    Article  Google Scholar 

  • Stone, R. (2008). The scope of IMF conditionality. International Organization, 62, 589–620.

    Article  Google Scholar 

  • Tomz, M. (2007). Reputation and international cooperation. Princeton: Princeton University Press.

    Google Scholar 

Download references

Acknowledgments

We thank the editor Andreas Haufler, Enlinson Mattos, Mauro Rodrigues Jr, André Portela Souza, two anonymous referees and seminar participants at the ANPEC Meeting 2013 (Iguaçu) and the Sao Paulo School of Economics – FGV for helpful comments. Bernardo Guimaraes gratefully acknowledges financial support from CNPq.

Author information

Authors and Affiliations

  1. Sao Paulo School of Economics – FGV, São Paulo, Brazil

    Bernardo Guimaraes & Oz Iazdi

Authors
  1. Bernardo Guimaraes
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Oz Iazdi
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Bernardo Guimaraes.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Guimaraes, B., Iazdi, O. IMF conditionalities, liquidity provision, and incentives for fiscal adjustment. Int Tax Public Finance 22, 705–722 (2015). https://doi.org/10.1007/s10797-014-9329-9

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10797-014-9329-9

Keywords

JEL Classification

Search

Navigation