ROLE OF THE IMF UNDER SIGNAL NOISE

This paper theoretically analyzes the early warning system (EWS) of the IMF based on the principal-agent model. We search for the trade-off of the optimal contract of the IMF under interim intervention and signal noise. The main findings are as follows. First, when the net loss coming from noise under a good fundamental is higher than the net gain by an interim intervention under a bad fundamental, the debtor country exerts less effort as the noise effect becomes larger. Second, when the net loss in a good fundamental is smaller than the net gain in a bad fundamental, an accurate signal may give rise to the moral hazard problem. Third, when the marginal utility by the intervention of the IMF is higher on bad fundamentals than on good fundamentals, the higher ability of the IMF to mitigate the crisis will elicit a weak policy effort from the country. On the other hand, when the economy has higher marginal utility in case of good fundamentals, deeper intervention of the IMF offers an incentive of a stronger policy effort to the country. Fourth, mandating the IMF to care about a country's welfare as well as safeguarding its resources does not necessarily imply that the debtor country will exert less effort