This paper presents a principal-agent model of IMF conditional lending, in the aftermath of a capital-account liquidity crisis. We show that traditional ex-post conditionality can be effective in safeguarding the Funds resources, allowing for the provision of efficient emergency lending and reducing inefficient ex-ante credit rationing if the capital outflow which triggers the crisis is not excessive. We apply the baseline model to analyse the issue of debtor moral hazard and private sector involvement (PSI), which have characterised the recent debate on reforming the International Financial Architecture. We show that debtor moral hazard is only a concern if the IMF cannot commit to make the post-crisis participation constraint of the debtor country binding, and that it can only be resolved via ex-ante conditionality (or pre-qualification). Attempts to reduce debtor moral hazard may however compromise the Funds ability to safeguard its resources ex-post. We also show that PSI in the solution of balance of payments crisis is a central determinant of the effectiveness of both crisis prevention and resolution efforts on the part of the IMF. PSI may be an enabling condition for efficient crisis resolution, and may therefore be imposed even by a PSI-averse IMF. Moreover, there are conditions under it is optimal for the IMF to ex-ante precommit to a tough, and ex-post sub-optimal, PSI policy, in order to mitigate investor moral hazard.
