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Debt overhang, liquidity constraints and adjustment incentives

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  • Hofman, Bert
  • Reisen, Helmut

Abstract

Investment in most heavily indebted countries has been weak since 1982. Several papers (Krugman, 1988; Corden, 1988; Sachs, 1989) have subsequently established the debt overhang proposition: the existence of a heavy debt burden reduces the incentive to invest.1 This proposition has given an important rationale for the 1989 shift in international debt management, emphasizing debt relief rather than new money for problem debtors. This paper will raise doubts against the debt overhang proposition: Its analytical implications are found to be ambiguous, its empirical content is found to be weak. We conclude, that investment in the average debtor country is likely to benefit more from new lending than from debt reduction.

Suggested Citation

  • Hofman, Bert & Reisen, Helmut, 1990. "Debt overhang, liquidity constraints and adjustment incentives," Kiel Working Papers 432, Kiel Institute for the World Economy (IfW Kiel).
    • Handle: RePEc:zbw:ifwkwp:432
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    References listed on IDEAS

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    1. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
    2. 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.
    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. Jeffrey D. Sachs, 1989. "Introduction to "Developing Country Debt and the World Economy"," NBER Chapters, in: Developing Country Debt and the World Economy, pages 1-34, National Bureau of Economic Research, Inc.
    5. 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.
    6. 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.
    7. W. Max Corden, 1988. "Debt Relief and Adjustment Incentives," IMF Staff Papers, Palgrave Macmillan, vol. 35(4), pages 628-643, December.
    8. 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 971-987, December.
    9. Jeffrey D. Sachs, 1989. "Conditionality, Debt Relief, and the Developing Country Debt Crisis," NBER Chapters, in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages 255-296, National Bureau of Economic Research, Inc.
    10. Claessens, Stijn & Diwan, Ishac, 1989. "Conditionality and debt relief," Policy Research Working Paper Series 213, The World Bank.
    11. Jeffrey D. Sachs, 1989. "Developing Country Debt and the World Economy," NBER Books, National Bureau of Economic Research, Inc, number sach89-3, March.
    12. Jeffrey D. Sachs, 1989. "Conditionality, Debt Relief, and the Developing Country Debt Crisis," NBER Chapters, in: Developing Country Debt and the World Economy, pages 275-284, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Tengstam, Sven, 2006. "Debt relief and adjustment effort in a multi-period model," Economics Letters, Elsevier, vol. 91(1), pages 127-130, April.
    2. Kumar, Saten & Paradiso, Antonio, 2011. "Assessing Sustainability of the Irish Public Debt," MPRA Paper 35295, University Library of Munich, Germany.
    3. Thierry Mayer, 2006. "Policy Coherence for Development : A Background paper on Foreign Direct Investment," SciencePo Working papers Main hal-01065640, HAL.
    4. Klodt, Henning, 1990. "Government support for restructuring the East German economy," Kiel Working Papers 450, Kiel Institute for the World Economy (IfW Kiel).
    5. repec:hal:wpspec:info:hdl:2441/10184 is not listed on IDEAS
    6. 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.
    7. repec:spo:wpecon:info:hdl:2441/10184 is not listed on IDEAS
    8. Helmut Reisen, 1991. "The Brady Plan and adjustment incentives," Intereconomics: Review of European Economic Policy, Springer;ZBW - Leibniz Information Centre for Economics;Centre for European Policy Studies (CEPS), vol. 26(2), pages 69-73, March.
    9. 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;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 127(2), pages 281-299, June.
    10. Yilmaz Akyüz, 2007. "Debt Sustainability in Emerging Markets: A Critical Appraisal," Working Papers 61, United Nations, Department of Economics and Social Affairs.
    11. repec:hal:spmain:info:hdl:2441/10184 is not listed on IDEAS

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