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Debt Forgiveness: the Case for Hyper-Incentive Contracts

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  • Douglas Menzies, G.

Abstract

We review two proposals for debt forgiveness; the Highly Indebted Poor Country Initiative (HIPC) and the Jubilee 2000 Coalition Initiative (J2K). We then consider the workhorse model of debt forgiveness (Krugman 1988). We show that the workhorse model solution is a sub-optimal contract, where the incentive parameter is set without regard to the cost of effort. A fully-optimal debt-overhang contract is derived, with an incentive parameter greater than the marginal social benefit of extra effort. The so-named Hyper-Incentive Contract eliminates the effects of moral hazard arising from hidden effort, and provides a fuller rationale for case-by-case debt-overhang contracts.

Suggested Citation

  • Douglas Menzies, G., 2000. "Debt Forgiveness: the Case for Hyper-Incentive Contracts," Economics Series Working Papers 9937, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:9937
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    2. repec:dau:papers:123456789/4089 is not listed on IDEAS
    3. Michaelowa, Katharina, 2003. "The Political Economy of the Enhanced HIPC-Initiative," Public Choice, Springer, vol. 114(3-4), pages 461-476, March.

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    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F35 - International Economics - - International Finance - - - Foreign Aid

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