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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. Helpman, Elhanan, 1989. "The Simple Analytics of Debt-Equity Swaps," American Economic Review, American Economic Association, vol. 79(3), pages 440-51, June.
  2. P.R. Agenor & J. Aizenman & A. Hoffmaister, 1998. "Contagion, Bank Lending Spreads and Output Fluctuations," NBER Working Papers 6850, National Bureau of Economic Research, Inc.
  3. Joshua Aizenman & Nancy Marion, 1999. "Uncertainty and the disappearance of international credit," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  4. Pierre-Richard Agénor & Joshua Aizenman, 1998. "Contagion and Volatility with Imperfect Credit Markets," IMF Staff Papers, Palgrave Macmillan, vol. 45(2), pages 207-235, June.
  5. Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1986. "The Pure Theory of Country Risk," NBER Working Papers 1894, National Bureau of Economic Research, Inc.
  6. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  7. Paul R. Krugman, 1988. "Financing vs. Forgiving a Debt Overhang," NBER Working Papers 2486, National Bureau of Economic Research, Inc.
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