Country Insurance

Abstract

The recent wave of financial crises has fueled the debate on the effect of IFIs intervention on governments' incentives to undertake reforms. In this paper we treat this intervention more generally as a country insurance contract, and examine its implications in a stylized set-up. More precisely, we identify the conditions under which the positive insurance effect dominates moral hazard considerations, and the channels through which this is achieved. In particular, we find that the case for country insurance is stronger for crisis-prone volatile economies, especially so if assistance is made contingent on the occurrence of adverse external macroeconomic shocks. Overall, our findings argue in favor of fairly-priced country insurance or insurance-type standing credit facilities that can be factored in ex ante by the borrowing government, as opposed to the customized discretionary bailoutsFinancial Crises, Bailouts, Moral Hazard, Insurance Effect,