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Self-Fulfilling Debt Crises in Theory and Practice

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  • Daniel Cohen
  • Sébastien Villemot

Abstract

This paper analyzes econometrically how a country`s post-crisis debt ratio could be forecast, in the aftermath of a debt crisis, from the previous debt-to-GDP ratio. A critical parameter is simply the debt-to-PPP-GDP ratio, where PPP-GDP is, in current international dollars, the Summers-Heston value. In this formulation, this paper shows that the Latin American paradox disappears. This then leads to a simple conclusion: debt crises are more frequent in Latin American countries because they have more damaging consequences on the market value of GDP. This itself appears to be closely related to the fact that pre-crisis Latin American exchange rates are also overvalued (for a similar emphasis, see Calvo et al. , 2003). As a simple consequence of this model, the paper suggests computing the debt-to-PPP-GDP ratio as a new standard for analyzing debt sustainability.

Suggested Citation

  • Daniel Cohen & Sébastien Villemot, 2006. "Self-Fulfilling Debt Crises in Theory and Practice," Research Department Publications 4467, Inter-American Development Bank, Research Department.
  • Handle: RePEc:idb:wpaper:4467
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    1. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-661, September.
    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. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2002. "Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina's Lessons," IDB Publications (Working Papers) 1909, Inter-American Development Bank.
    4. Cohen, Daniel & Soto, Marcelo, 2002. "Why are Poor Countries Poor? A Message of Hope which Involves the Resolution of a Becker/Lucas Paradox," CEPR Discussion Papers 3528, C.E.P.R. Discussion Papers.
    5. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
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