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Financial sector inefficiencies and the debt Laffer curve

  • Pierre-Richard Agénor

    (School of Economic Studies and Centre for Growth and Business Cycle Research, University of Manchester, UK)

  • Joshua Aizenman

    (Department of Economics, University of California, USA, and National Bureau of Economic Research, USA)

This paper analyses the implications of inefficient financial intermediation for debt management in a model where firms rely on bank credit to finance their working capital needs and lenders face state verification and contract enforcement costs. We show that lower expected productivity, higher enforcement and verification costs, or higher volatility of productivity shocks, may shift a country to the wrong side of its debt Laffer curve, with potentially sizable output and welfare losses. We also show that debt relief may bring few welfare benefits unless it is accompanied by reforms aimed at reducing financial sector inefficiencies. Copyright © 2005 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.251
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 10 (2005)
Issue (Month): 1 ()
Pages: 1-13

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Handle: RePEc:ijf:ijfiec:v:10:y:2005:i:1:p:1-13
Contact details of provider: Web page: http://www.interscience.wiley.com/jpages/1076-9307/

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  1. Joshua Aizenman & Nancy Marion, 1999. "Uncertainty and the disappearance of international credit," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  2. Pierre-Richard Agenor & Joshua Aizenman, 1997. "Contagion and Volatility with Imperfect Credit Markets," NBER Working Papers 6080, National Bureau of Economic Research, Inc.
  3. Helpman, Elhanan, 1989. "The Simple Analytics of Debt-Equity Swaps," American Economic Review, American Economic Association, vol. 79(3), pages 440-51, June.
  4. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, vol. 29(3), pages 253-268, November.
  5. Agenor, Pierre-Richard & Aizenman, Joshua & Hoffmaister, Alexander, 1999. "Contagion, bank lending spreads, and output fluctuations," Policy Research Working Paper Series 2186, The World Bank.
  6. Eaton, Jonathan & Gersovitz, Mark & Stiglitz, Joseph E., 1986. "The pure theory of country risk," European Economic Review, Elsevier, vol. 30(3), pages 481-513, June.
    • Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1991. "The Pure Theory of Country Risk," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 391-435 National Bureau of Economic Research, Inc.
  7. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
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