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Interest rates, growth, and external debt : the macroeconomic impact of Mexico's Brady deal

  • Claessens, Stijn
  • Oks, Daniel
  • van Wijnbergen, Sweder

Interest rates fell sharply after Mexico's Brady deal, and private investment and growth recovered. The authors show that the main benefit of debt relief was not to lower expected payments but to reduce uncertainty. Reduced uncertainty was found to be the dominant factor in explaining the positive macroeconomic response (largely because of its favorable effect on exchange rate crises). Econometrically, they find that the variability of the future net transfer had a significant impact but the average of the future net transfer itself did not. Their results confirm that debt reduction has a positive macroeconomic effect, but reject the debt overhang hypothesis (the benefits to growth of a reduced tax burden) as the dominant factor. Their main conclusion: debt reduction can have a much greater impact than the magnitude of relief, coupled with standard growth models, would suggest. The secondary effects on private investment of reduced uncertainty about government policy is likely to be more important than the direct amount of debt reduction itself. But private investment is unlikely to increase if uncertainty remains about future domestic macroeconomic stability and reform. The debt package would not have succeeded if the government had not put through a successful domestic reform program before the debt relief package.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1147.

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Date of creation: 30 Jun 1993
Date of revision:
Handle: RePEc:wbk:wbrwps:1147
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  1. J. Bradford De Long & Barry Eichengreen, 1991. "The Marshall Plan: History's Most Successful Structural Adjustment Program," NBER Working Papers 3899, National Bureau of Economic Research, Inc.
  2. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, vol. 29(3), pages 253-268, November.
  3. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," NBER Working Papers 2926, National Bureau of Economic Research, Inc.
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