How Can the IMF Catalyse Private Capital Flows? A Model

Abstract

This paper presents a model to explain how IMF programmes can catalyse private capital flows following a financial crisis, a concept that was at the heart of the IMF's strategy for dealing with capital account crises in the late 1990s. In the model, the IMF lends funds below the prevailing market interest rate and it is this subsidy that induces the borrowing country to exert adjustment effort to avoid default. By preventing default, future marginal rates of return on investment are kept high, thereby encouraging private capital flows. The IMF may also have a signalling role if it has superior information about debtor type and can affect the interest rate charged in the immediate aftermath of a crisis. In practice, however, IMF programmes based on the catalytic approach have been disappointing and actual private capital flows have been considerably below those projected. Therefore, the paper also considers how capital flows derived from the model are sensitive to the assumptions made. The paper concludes by discussing the policy implications of the analysis for IMF programme design.

Keywords: International Monetary Fund, crisis resolution, catalytic finance

JEL Classification: F32, F33, F34