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Voluntary Debt Reduction: Incentives and Welfare

  • Elhanan Helpman

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.

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File URL: http://www.nber.org/papers/w2692.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2692.

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Date of creation: Aug 1988
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Publication status: published as International Monetary Fund Staff Papers, Vol. 36, No. 3, pp. 580-611,(September 1989).
Handle: RePEc:nbr:nberwo:2692
Note: ITI IFM
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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Web page: http://www.nber.org
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  1. Michael P. Dooley, 1988. "Buy-Backs and Market Valuation of External Debt," IMF Staff Papers, Palgrave Macmillan, vol. 35(2), pages 215-229, June.
  2. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
  3. Claessens, Stijn, 1990. "The debt laffer curve: Some estimates," World Development, Elsevier, vol. 18(12), pages 1671-1677, December.
  4. W. Max Corden, 1988. "An International Debt Facility?," IMF Staff Papers, Palgrave Macmillan, vol. 35(3), pages 401-421, September.
  5. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  6. Eaton, Jonathan, 1987. "Public Debt Guarantees and Private Capital Flight," World Bank Economic Review, World Bank Group, vol. 1(3), pages 377-95, May.
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