Moral Hazard and the IMF Bailout

In the wake of the Asian financial crisis, the IMF is again facing calls for increased funding. In addition to bailing out financially troubled governments and companies, IMF loan programs also offer countries the opportunity to reform their economic policies and rethink their relationship with the international financial system. However, many important questions remain unanswered regarding IMF loans. The literature has mixed empirical findings about whether IMF-backed lending creates moral hazard among investors. This inconsistency is largely due to the different research methodologies employed by authors investigating this question. Dreher (2006) summarized the three most popular methods of examining this issue, and concluded that research in this field has yielded inconsistent results.

The conditions attached to IMF aid force recipient countries to sacrifice policy autonomy and implement strict economic reforms that are designed to return budget deficits to surplus in the short term. However, these policies often lead to inactive business investment, deteriorating government service and higher unemployment rates, which further damage the economies of these countries. In addition, IMF-backed loans may socialize investors’ losses. Therefore, it is in the enlightened self-interest of all countries to strengthen market-based alternatives to IMF lending and to eliminate the need for IMF bailouts.

Rather than providing financial support for the wealthy and powerful, IMF loans should focus on addressing the fundamental problems that cause financial crises, such as floating exchange rates, internationally accepted accounting and disclosure practices, and unfettered private financial markets. These essential reforms would promote a stable international monetary system and facilitate long-term economic development.