Liquidity protection versus Moral Hazard: the role of the IMF

Abstract

This paper develops a simple game between the IMF a county and a set of atomistic private investors. The model is motivated by the case of Argentina. Under reasonable assumptions, the one shot game has no Nash equilibrium in pure strategies. Consider- ing an equilibrium in mixed strategies, conditions are derived on whether the IMF should exist. A “cooperative first best” may be supported in a repeated game by a “minimum punishment strat- egy” that may be optimal but may break down if the probability of insolvency rises. This implies that countries are likely to de- viate in bad times placing the IMF in an “impossible position”. It is suggested that the international financial architecture (IFA) remains incomplete.