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Voluntary Debt Reduction: Incentives and Welfare

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  • International Monetary Fund

Abstract

In an economy with a debt overhang, investment depends on expected tax rates. On the other hand, expected tax rates depend on the debt’s face value. Therefore investment depends on the face value of debt. I show that this may lead to a positive or negative association between debt and investment depending on the degree of international capital mobility and attitudes toward risk. There may also exist multiple equilibria; with high and low investment levels. The paper explores the desirability of debt reduction in this environment. First, it characterizes circumstances in which debt reduction is desirable from the collective point of view of the creditors. Second, it formulates the forgiveness decision as a noncooperative game among creditors and explores the scope for debt reduction as an outcome of this game.

Suggested Citation

  • International Monetary Fund, 1988. "Voluntary Debt Reduction: Incentives and Welfare," IMF Working Papers 1988/084, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1988/084
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    Cited by:

    1. Joshua Aizenman & Eduardo R. Borensztein, 1989. "Strategic Investment in a Debt Bargaining Framework," NBER Working Papers 3019, National Bureau of Economic Research, Inc.

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