Outcomes-Based Conditionality: Its Role and Optimal Design

This paper employs a principal-agent framework to analyze the role and design of outcomes-based conditionality in the presence of market frictions and domestic opposition. The results suggest that outcomes-based conditionality is a good option for the IMF when opposition to reforms is relatively weak and when IMF loans are unsubsidized. The only role conditionality ends up playing in this case is that of an efficiency tool to ensure efficient allocation of resources in the presence of market frictions. The benefits of outcomes-based conditionality in the presence of strong opposition are less clear, and using this conditionality as an incentive tool would require IMF financing to be subsidized. Copyright 2006, International Monetary Fund