Title: Dealing with destabilizing 'market discipline'
Description: "If interest rates (country spreads) rise, debt can rapidly be subject to a snowball effect, which then becomes self-fulfilling with regard to the fundamentals themselves.  This is a market imperfection, because we cannot be confident that the unaided market will choose the good equilibrium' over the bad equilibrium'.  We see here a fundamental flaw in the process of market discipline.  We propose a policy intervention to deal with this structural weakness in the mechanisms of international capital flows.  This is based on a simple taxonomy that enables us to break down the origin of crises into three components: a crisis of confidence (spreads and currency crisis), a crisis of fundamentals (real growth rate), and a crisis of economic policy (primary deficit).  The policy would seek to short-circuit confidence crises, partly by using IMF support to improve ex ante incentives"--National Bureau of Economic Research web site.
Subjects: Economic stabilization, Interest rates, External Debts, Capital movements