IPD AI Insights

Compensatory Financing for Shocks

03/13/2008
Working Paper
Global Governance

One of the key aims of a development supportive international financial architecture—that is, one supporting growth and poverty reduction— is the provision of adequate countercyclical official liquidity in the face of external shocks. External shocks tend to have very large negative effects on developing economies’ growth, investment and poverty.

Thus, provision of appropriate official liquidity and aid can potentially be very effective for protecting economic growth (and the income of poor people) from the negative impact of economic shocks, whether these relate to terms of trade, volatility of private capital flows or natural disasters. In this paper the authors focus mainly on shocks arising from trade. They argue that there is a great urgency to improve existing compensatory financing mechanisms quickly and/or design new ones where gaps exist.