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Debt Overhang, Liquidity Constraints and Adjustment Incentives

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  • Bert Hofman
  • Helmut Reisen

Abstract

Investment in most heavily indebted countries has been weak since 1982. The widely accepted debt overhang proposition interprets the investment drop as a moral hazard problem: a heavy debt burden raises the incentive to consume, because the marginal benefit of investment would go to the creditor. This paper develops several hypotheses on optimal reactions of a credit-constrained debtor country on an increase in debt, on variations in the credit constraint, on changes in interest rates, and contrasts these with the predictions stemming from the debt overhang proposition. Empirical specifications of conventional investment functions and consumption functions (along the Permanent Income Hypothesis) lead to reject the debt overhang proposition, but find that the switch from positive to negative external transfers to the debtor countries is an important explanation for their investment drop. The major policy conclusion is that the 1989 shift in international debt management (the Brady ... Dans la plupart des pays lourdement endettés, l'investissement, depuis 1982, s'est caractérisé par une grande faiblesse. Selon la thèse généralement admise de la "dette trop élevée", la chute de l'investissement relève d'une problématique d'ordre psychologique : le fardeau de la dette stimule la consommation, parce que le bénéfice marginal de tout investissement semble devoir échapper aux bailleurs de fonds. Cet ouvrage présente plusieurs hypothèses relatives aux réactions les mieux adaptées, de la part des pays débiteurs victimes de limitations de crédits, dans les cas d'une augmentation de la dette, de modifications des limitations de crédit, d'une variation des taux d'intérêt. Cette étude compare également ces hypothèses aux prévisions découlant de la thèse de la "dette trop élevée". Les caractéristiques empiriques des fonctions conventionnelles d'investissements et de consommation (selon l'hypothèse du revenu permanent – Permanent Income Hypothesis) invalident la thèse ...

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Bibliographic Info

Paper provided by OECD Publishing in its series OECD Development Centre Working Papers with number 32.

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Date of creation: Oct 1990
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Handle: RePEc:oec:devaaa:32-en

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  1. Philippe Callier, 1989. "Debt Relief and Adjustment Incentives in a Financially Open Economy: Comment on Corden," IMF Staff Papers, Palgrave Macmillan, vol. 36(2), pages 514-522, June.
  2. W. Max Corden, 1988. "Debt Relief and Adjustment Incentives," IMF Staff Papers, Palgrave Macmillan, vol. 35(4), pages 628-643, December.
  3. Alain Ize & Guillermo Ortiz, 1987. "Fiscal Rigidities, Public Debt, and Capital Flight," IMF Staff Papers, Palgrave Macmillan, vol. 34(2), pages 311-332, June.
  4. Reisen, Helmut, 1989. "Public debt, North and South," Policy Research Working Paper Series 253, The World Bank.
  5. Jeffrey D. Sachs, 1989. "Developing Country Debt and Economic Performance. The International Financial System," NBER Chapters, in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages -12 National Bureau of Economic Research, Inc.
  6. Froot, Kenneth A, 1989. "Buybacks, Exit Bonds, and the Optimality of Debt and Liquidity Relief," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 49-70, February.
  7. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  8. Jeffrey D. Sachs, 1989. "Introduction to "Developing Country Debt and Economic Performance, Volume 1: The International Financial System"," NBER Chapters, in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages 1-36 National Bureau of Economic Research, Inc.
  9. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
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Cited by:
  1. Bert Hofman & Helmut Reisen, 1991. "Some evidence on debt-related determinants of investment and consumption in heavily indebted countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 127(2), pages 281-299, June.
  2. Warner, Andrew M., 1993. "Did the debt crisis or declining oil prices cause Mexico's investment collapse?," Policy Research Working Paper Series 1102, The World Bank.
  3. Helmut Reisen, 1991. "The Brady Plan and adjustment incentives," Intereconomics: Review of European Economic Policy, Springer, vol. 26(2), pages 69-73, March.
  4. Klodt, Henning, 1990. "Government support for restructuring the East German economy," Kiel Working Papers 450, Kiel Institute for the World Economy.
  5. Kumar, Saten & Paradiso, Antonio, 2011. "Assessing Sustainability of the Irish Public Debt," MPRA Paper 35295, University Library of Munich, Germany.
  6. Yilmaz Akyüz, 2007. "Debt Sustainability in Emerging Markets: A Critical Appraisal," Working Papers 61, United Nations, Department of Economics and Social Affairs.

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