Welfare Implications of a Second Lender in the International Markets

The role of an extra lender in the international markets – such the IMF or another similar institution - has been widely covered in academic discussions and among policy makers. However, there is neither a clear answer nor a consensus about its welfare consequences. On the one hand, it is argued that the moral hazard consequences of an extra lender could be strong enough to offset any positive effect of an additional source of funding. On the other hand, it is argued that moral hazard consequences could be negligible and, therefore, the second lender’s presence could be welfare improving. The aim of this paper is twofold. First, it provides a numerical perspective about the welfare effect of an active second lender. Second, it sheds light on the debt dynamics in the two-lender case. The main result is that the second lender is not beneficial from a welfare standpoint for a wide range of parameters. Without coordination, the estimates imply welfare losses that range from 1.5% to 6% of GDP, depending on the severity of the second lender’s penalties. On the other hand, if a coordination mechanism is imposed, such as the second lender acting as a lender of last resort, then the model will mimic a one-lender model where the first lender is crowded out from the market. l II) could be helpful on this task.