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Growth and External Debt Under Risk of Debt Repudiation

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  • Daniel Cohen
  • Jeffrey Sachs

Abstract

We analyze the pattern of growth of a nation which borrows abroad and which has the option of repudiating its foreign debt. We show that the equilibrium strategy of competitive lenders is to make the growth of the foreign debt contingent on the growth of the borrowing country. We give a closed-form solution to a linear version of our model. The economy, in that case, follows a two-stage pattern of growth. During the first stage, the debt grows more rapidly than the economy. During the second stage, both the debt and the economy grow at the same rate, and more slowly than in the first stage. During this second stage, the total interest falling due on the debt is never entirely repaid; only an amount proportional to the difference of the rate of interest and the rate of growth of the economy is repaid each period.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1703.

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Date of creation: Sep 1985
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Publication status: published as European Economic Review, 1985
Handle: RePEc:nbr:nberwo:1703

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  1. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(2), pages 147-175, November.
  2. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, Elsevier, vol. 7(2), pages 117-161, June.
  3. Antoine d'Autume & Philippe Michel, 1985. "Epargne, investissement et monnaie dans une perspective intertemporelle," Revue Économique, Programme National Persée, Programme National Persée, vol. 36(2), pages 243-290.
  4. Foley, Duncan K. & Hellwig, Martin F., 1975. "A note on the budget constraint in a model of borrowing," Journal of Economic Theory, Elsevier, Elsevier, vol. 11(2), pages 305-314, October.
  5. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  6. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  9. Jeffrey D. Sachs, 1982. "Aspects of the Current Account Behavior of OECD Economies," NBER Working Papers 0859, National Bureau of Economic Research, Inc.
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