The central question raised in this paper is the desirability of state-cont
ingent contracts under imperfect policy credibility. The paper shows a benc
hmark case in which imperfect credibility of a trade liberalization program
is distorting, and the distortion is magnified by state-contingent markets
. in addition, it examines the welfare implications of gaining credibility,
concluding that, in general, more credibility is better than less, and exa
mines the moral hazard faced by policymakers in carrying out reform in case
the private sector is able to obtain insurance against its discontinuation
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