Insurance against recession

The International Monetary Fund (IMF) has proposed governments should offer recession insurance and banks should insist companies buy it before lending to them in the same way mortgage lenders insist borrowers buy buildings cover.

The proposal in a 37-page paper on fiscal stimulus, called Fiscal Policy for the Crisis. (www.imf.org/external/np/pp/eng/2008/122308.pdf )

The report said: “The government could provide insurance against extreme recessions by offering contracts, with payment, for example, contingent on GDP growth falling below some threshold level. Banks could condition loan approvals on firms having purchased such insurance from the government. This is analogous to the flood insurance that mortgage companies often require from borrowers. While such contracts would most likely be attractive to firms, which suffer disproportionately during large recessions, they could be open to individuals as well. Widespread use of such contracts would provide an additional automatic stabilizer because payments would be made when they are most needed, namely in bad times. Such a market would also provide a market-based view of future output and the likelihood of severe shocks. (GDP-linked bonds, which have been discussed in the academic literature for some time, would also go some way towards the same goal.)”

It continued: “An obvious worry about such a scheme is counterparty risk, ie, that the government may not be able or willing to honour its obligations. The contingent liabilities created by providing insurance should be included appropriately in the budget and should be taken into consideration when calculating medium-run fiscal sustainability.

In an interview on the IMF website, one of the report’s authors, Olivier Blanchard, said: “We've been brainstorming about alternative measures that governments could consider. One idea is that governments could offer insurance against extreme recessions. For example, governments could offer a contract with payments contingent on GDP growth falling below some threshold level, and banks may condition loan approvals on firms having purchased such insurance. In principle, this would work a bit like the flood insurance many mortgage holders are required to take out.”

Reuters reports that the IMF has not raised the subject with any governments, according Carlo Cottarelli, director of the IMF's fiscal affairs department and another of the report’s authors.