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External debt, planning horizon, and distorted credit markets

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  • Aizenman, Joshua

Abstract

The purpose of this paper is to study the role of policies in the presence of country risk with overdiscounting by the policy maker. Overdiscounting may reflect political uncertainty, which makes the effective planning horizon of the centralized government shorter than that of the private sector. The consequence of overdiscounting is to shift the supply curve facing the economy leftwards. The role of optimal borrowing policies in the presence of country risk is to discourage borrowing for consumption purposes, encourage investment in openness, and discourage investment in activities that reduce openness. The effect of overdiscounting by the policy maker is to increase the values of the optimal policy instruments (i.e. to increase the magnitude of the borrowing taxes and subsidies). Increasing the relative importance of open activities can be viewed as a way to reduce the harmful consequences of overdiscounting. Overdiscounting may rationalize various conditionality clauses that will induce the economy to follow the desired credit market policies.
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Suggested Citation

  • Aizenman, Joshua, 1990. "External debt, planning horizon, and distorted credit markets," Journal of International Money and Finance, Elsevier, vol. 9(2), pages 138-158, June.
  • Handle: RePEc:eee:jimfin:v:9:y:1990:i:2:p:138-158
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    References listed on IDEAS

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    1. Alesina, Alberto & Tabellini, Guido, 1989. "External debt, capital flight and political risk," Journal of International Economics, Elsevier, vol. 27(3-4), pages 199-220, November.
    2. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
    3. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-594, June.
    4. Edwards, Sebastian, 1986. "Country risk, foreign borrowing, and the social discount rate in an open developing economy," Journal of International Money and Finance, Elsevier, vol. 5(1, Supple), pages 79-96, March.
    5. R. Dornbusch, 1984. "External Debt, Budget Deficits and Disequilibrium Exchange Rates," Working papers 347, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, vol. 94(374), pages 287-307, June.
    7. Aizenman, Joshua, 1989. "Country Risk, Incomplete Information and Taxes on International Borrowing," Economic Journal, Royal Economic Society, vol. 99(394), pages 147-161, March.
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    Cited by:

    1. Cabral, Celia C., 1998. "HICs' optimal trade openness and the modelling of the default penalty," Journal of International Money and Finance, Elsevier, vol. 17(5), pages 803-811, October.

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