Question

Answer the following questions concerning proposals to reform long-term development lending programs currently offered by the IMF and World Bank.

a. Why might the World Bank face moral hazard problems if it were to offer to provide funds to governments that promise to allocate the funds to major institutional reforms aimed at enhancing economic growth?

b. How does the IMF face an adverse selection problem if it is considering making loans to governments in which the ruling parties have already shown predispositions to try to "buy" votes by creating expensive public programs in advance of elections? How might following an announced rule in which the IMF cuts off future loans to governments that engage in such activities reduce this problem and promote increased economic growth in nations that do receive IMF loans?

Short answer

(a) Some governments may fail to follow through on their promise to appropriate money for national development.

(b) The majority of governments that apply for IMF loans do so with the intention of using the funds to buy votes.

Step-by-step solution

Introduction.

The International Monetary Fund (IMF) is an international organization with a variety of objectives.

Causes to provide funds to governments that promise to allocate the funds (part a).

The World Bank may face a moral hazard problem because some governments may not keep their promise to allocate funds for national development.

Reasons for the IMF face an adverse selection problem if it is considering making loans to governments (part b).

The majority of governments that apply for IMF loans do so with the intention of using the funds to buy votes. The decision to halt future loans to such countries would undoubtedly aid in the promotion of economic growth.