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Voluntary Debt Reduction: Incentives and Welfare

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  • Elhanan Helpman

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

  • Elhanan Helpman, 1988. "Voluntary Debt Reduction: Incentives and Welfare," NBER Working Papers 2692, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2692
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    References listed on IDEAS

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    1. Eaton, Jonathan, 1987. "Public Debt Guarantees and Private Capital Flight," World Bank Economic Review, World Bank Group, vol. 1(3), pages 377-395, May.
    2. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
    3. 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.
    4. Claessens, Stijn, 1990. "The debt laffer curve: Some estimates," World Development, Elsevier, vol. 18(12), pages 1671-1677, December.
    5. W. Max Corden, 1988. "An International Debt Facility?," IMF Staff Papers, Palgrave Macmillan, vol. 35(3), pages 401-421, September.
    6. Michael P. Dooley, 1988. "Buy-Backs and Market Valuation of External Debt," IMF Staff Papers, Palgrave Macmillan, vol. 35(2), pages 215-229, June.
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    Cited by:

    1. Tengstam, Sven, 2006. "Debt relief and adjustment effort in a multi-period model," Economics Letters, Elsevier, vol. 91(1), pages 127-130, April.
    2. Rolf Maier, 2005. "External Debt and Pro-Poor Growth," Macroeconomics 0504031, EconWPA.
    3. Michael P. Dooley, 1994. "A Retrospective on the Debt Crisis," NBER Working Papers 4963, National Bureau of Economic Research, Inc.
    4. Agenor, Pierre-Richard & Aizenman, Joshua, 1999. "Financial sector inefficiencies and coordination failures : implications for crisis management," Policy Research Working Paper Series 2185, The World Bank.
    5. Maier, Rolf, 2005. "External Debt and Pro-Poor Growth," Proceedings of the German Development Economics Conference, Kiel 2005 23, Verein für Socialpolitik, Research Committee Development Economics.
    6. Andrew M. Warner, 1991. "Did the debt crisis cause the investment crisis?," International Finance Discussion Papers 418, Board of Governors of the Federal Reserve System (U.S.).
    7. Hayri, Aydin, 2000. "Debt relief," Journal of International Economics, Elsevier, vol. 52(1), pages 137-152, October.
    8. repec:dau:papers:123456789/4089 is not listed on IDEAS
    9. Long, Ngo Van, 1989. "The political economy of the international debt crisis," Kiel Working Papers 384, Kiel Institute for the World Economy (IfW).
    10. Fafchamps, Marcel, 1996. "Sovereign debt, structural adjustment, and conditionality," Journal of Development Economics, Elsevier, vol. 50(2), pages 313-335, August.
    11. Berthelemy, Jean-Claude, 2001. "HIPC Debt Relief and Policy Reform Incentives," WIDER Working Paper Series 105, World Institute for Development Economic Research (UNU-WIDER).
    12. Johansson, Pernilla, 2010. "Debt Relief, Investment and Growth," World Development, Elsevier, vol. 38(9), pages 1204-1216, September.
    13. Fernandez-Ruiz, Jorge, 1996. "Debt and incentives in a dynamic context," Journal of International Economics, Elsevier, vol. 41(1-2), pages 139-151, August.
    14. Bowe, M. & Dean, J.W., 1997. "Has the Market Solved the Sovereign-Debt Crisis?," Princeton Studies in International Economics 83, International Economics Section, Departement of Economics Princeton University,.
    15. Strand, Jon, 1995. "Lending terms, debt concessions, and developing countries' resource extraction," Resource and Energy Economics, Elsevier, vol. 17(2), pages 99-117, August.
    16. Oladi, Reza, 2003. "International involuntary lending and contingent default threat," International Review of Economics & Finance, Elsevier, vol. 12(2), pages 237-245.
    17. Michael Bowe & James W. Dean, 1997. "Debt-equity swaps and the enforcement of sovereign loan contracts," Journal of International Development, John Wiley & Sons, Ltd., vol. 9(1), pages 59-83.
    18. AGENOR Pierre-Richard & IZQUIERDO Alejandro & FOFACK Hippolyte, "undated". "IMMPA: A Quantitative Macroeconomic Framework for the Analysis of Poverty Reduction Strategies," EcoMod2003 330700003, EcoMod.
    19. Stephan Koren, 1992. "Debt relief for Eastern Europe — Its costs and the distribution of proceeds: Some preliminary results," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 128(4), pages 639-661, December.

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