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Interest rates, growth, and external debt : the macroeconomic impact of Mexico's Brady deal

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  • Claessens, Stijn
  • Oks, Daniel
  • van Wijnbergen, Sweder

Abstract

Interest rates fell sharply after Mexico's Brady deal, and private investment and growth recovered. The authors show that the main benefit of debt relief was not to lower expected payments but to reduce uncertainty. Reduced uncertainty was found to be the dominant factor in explaining the positive macroeconomic response (largely because of its favorable effect on exchange rate crises). Econometrically, they find that the variability of the future net transfer had a significant impact but the average of the future net transfer itself did not. Their results confirm that debt reduction has a positive macroeconomic effect, but reject the debt overhang hypothesis (the benefits to growth of a reduced tax burden) as the dominant factor. Their main conclusion: debt reduction can have a much greater impact than the magnitude of relief, coupled with standard growth models, would suggest. The secondary effects on private investment of reduced uncertainty about government policy is likely to be more important than the direct amount of debt reduction itself. But private investment is unlikely to increase if uncertainty remains about future domestic macroeconomic stability and reform. The debt package would not have succeeded if the government had not put through a successful domestic reform program before the debt relief package.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1147.

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Date of creation: 30 Jun 1993
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Handle: RePEc:wbk:wbrwps:1147

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Keywords: Environmental Economics&Policies; Public Sector Economics&Finance; Strategic Debt Management; Economic Theory&Research; Banks&Banking Reform;

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  1. J. Bradford De Long & Barry Eichengreen, 1993. "The Marshall Plan: History's Most Successful Structural Adjustment Programme," J. Bradford De Long's Working Papers _109, University of California at Berkeley, Economics Department.
  2. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, vol. 29(3), pages 253-268, November.
  3. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," NBER Working Papers 2926, National Bureau of Economic Research, Inc.
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Cited by:
  1. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
  2. Rudiger Dornbusch & Alejandro Werner, 1994. "Mexico: Stabilization, Reform, and No Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(1), pages 253-316.
  3. Bowe, M. & Dean, J.W., 1997. "Has the Market Solved the Sovereign-Debt Crisis?," Princeton Studies in International Economics 83, International Economics Section, Departement of Economics Princeton University,.
  4. Claessens, Stijn & Detragiache, Enrica & Kanbur, Ravi & Wickham, Peter, 1996. "Analytical aspects of the debt problems of heavily indebted poor countries," Policy Research Working Paper Series 1618, The World Bank.
  5. de Aghion, Beatriz Armendariz & de Hinestrosa, Patricia Armendariz, 1995. "Debt relief, growth and price stability in Mexico," Journal of Development Economics, Elsevier, vol. 48(1), pages 135-149, October.
  6. Barbone, Luca & Forni, Lorenzo, 1997. "Are markets learning? : behavior in the secondary market for Brady bonds," Policy Research Working Paper Series 1734, The World Bank.
  7. Canuto, Otaviano & Pinto, Brian & Prasad, Mona, 2012. "Orderly sovereign debt restructuring : missing in action !," Policy Research Working Paper Series 6054, The World Bank.

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