Does the IMF cause moral hazard and political business cycles? : Evidence from panel data

Abstract

Using panel data for 106 countries in 1971-1997, we estimate generalized least squares regressions to explain IMF lending as well as monetary and fiscal policies in the recipient countries. With respect to moral hazard, we find that a country's rate of monetary expansion and its government budget deficit is higher the less it has exhausted its borrowing potential in the Fund and the more credit it has received from the Fund. Moreover, the budget deficit is shown to be larger the higher the interest subsidy offered by the IMF. As for political business cycles, our evidence indicates that, even with a considerable number of control variables, IMF credits in the more democratic recipient countries are larger in pre-election and post-election years. Thus, IMF lending seems to facilitate the generation of political business cycles, while IMF conditionality may serve as a scapegoat for unpopular corrective measures after the election. The paper concludes with implications for IMF reform.

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