Financial crises and IMF intervention : is there a mutual connection?

Financial crises seem to constitute an indispensable part of the economic history of the last three decades becoming worldwide phenomena. Both developing and developed countries have suffered from these “black days” in the financial markets. In the case of developed countries, financial crises have been costly to the economy. However the damage that was imposed on developing countries seems to be far greater and they became victims most of the time. After a while conditions dictated necessity to correct apparent inefficiency of international markets in handling crises situations. Thus lenders of last resort notion came to the light. First domestic, which was mostly central banks of the countries, then in the view of spreading international financial crises, international lender of last resort appeared. In the latter case IMF was seen to take upon responsibility of stabilizing situations in case of ‘fire alarm’. Taken in the context of international financial markets, there is an emerging argument that IMF-led funding packages to countries suffering from financial crises have undermined efforts to forestall such crises, typical example of moral hazard problem. Moral hazard occurs when transaction has already been carried out between parties in the financial market. The hazard is that borrower could have incentives to engage in activities that are undesirable from lender’s point of view, i.e. those activities that will make it much less likely that borrower’s money will be paid out. In this study, we will try to find the correlation level between IMF lending and moral hazard problem. In the first part, historical review of the financial crises is given and theoretical explanation is presented. The second part of the work is about lenders of last resort, how they fit into the situation of financial distress, whether benefits from bailing out debtor is higher than the costs, in the face of moral hazard problem. Finally, in the last part of my thesis, I will evaluate correlation level between severity and frequency of financial crises and the IMF lending to the countries