International Financial Contagion and the IMF: A Theoretical Framework

31 Pages Posted: 31 Jan 2006

See all articles by Peter B. Clark

Peter B. Clark

International Monetary Fund (IMF)

Haizhou Huang

International Monetary Fund (IMF)

Date Written: September 2001

Abstract

We provide a model of contagion where countries borrow or lend for consumption smoothing at the market interest rate or a lower IMF rate. Highly indebted countries hit by large negative shocks to output will default. The resulting reduction in loanable funds raises interest rates, increases the vulnerability of other indebted countries, and can generate further rounds of defaults. In this environment the IMF can limit default and internalize the externality generated by contagion through its lending with conditionality. We characterize the IMF's optimal lending decision in mitigating the loss in world consumption.

Keywords: international financial contagion, conditionality, IMF

JEL Classification: E44, E61, F33, F34

Suggested Citation

Clark, Peter B. and Huang, Haizhou, International Financial Contagion and the IMF: A Theoretical Framework (September 2001). Available at SSRN: https://ssrn.com/abstract=879923 or http://dx.doi.org/10.2139/ssrn.879923

Peter B. Clark

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Haizhou Huang

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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