The Efficient Resolution of Capital Account Crises: How to Avoid Moral Hazard

Bank of England Working Paper No. 233

36 Pages Posted: 21 Feb 2005

See all articles by Gregor Irwin

Gregor Irwin

Bank of England

David Vines

University of Oxford - Balliol College - Department of Economics; Australian National University (ANU); Centre for Economic Policy Research (CEPR)

Date Written: October 2004

Abstract

This paper presents a model of capital account crises and uses it to study resolution mechanisms for both liquidity and solvency crises. It shows that liquidity crises should be dealt with by a standstill combined with IMF lending into arrears, whereas solvency crises should be resolved by debt write-downs. Dealing with solvency crises by lending would require a subsidy and this creates moral hazard, such as incentives for excessive borrowing, for too little equity financing and for investment in projects that are inefficient. The analysis underlines the importance of accurately assessing whether a crisis is rooted in a liquidity or a solvency problem.

Suggested Citation

Irwin, Gregor and Vines, David, The Efficient Resolution of Capital Account Crises: How to Avoid Moral Hazard (October 2004). Bank of England Working Paper No. 233, Available at SSRN: https://ssrn.com/abstract=670127 or http://dx.doi.org/10.2139/ssrn.670127

Gregor Irwin (Contact Author)

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David Vines

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Australian National University (ANU)

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Centre for Economic Policy Research (CEPR)

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