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The effect of new IMF lending announcements on capital markets depends on the lenderâs political motivations. There are conditions under which lending reduces the risk of a deepening crisis and reduces the risk premium demanded by market actors. On the other hand, the political interests that make lenders willing to lend weaken the credibility of commitments to reform, and the act of accepting an agreement reveals unfavorable information about the state of the borrowerâs economy. The net âcatalyticâ effect on the price of private borrowing depends on whether these effects dominate the beneficial effects of the liquidity the loan provides. Decomposing the contradictory effects of crisis lending provides an explanation for the discrepant empirical findings in the literature about market reactions. We test the implications of our theory by examining how sovereign bond yields are affected by IMF program announcements, loan size, the scope of conditions attached to loans, and measures of the geopolitical interests of the United States, a key IMF principal.
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