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Growth, debt, and sovereign risk in a small, open economy

  • Bhandari, Jagdeep S.
  • Ul Haque, Nadeem
  • Turnovsky, Stephen J.

The continuing debt crisis that many developing countries have faced in the current decade has underscored the need to understand the relationships between debt accumulation and growth, as well as the need to develop policy approaches that foster adjustment in the external account while maintaining the growth of output. The purpose of this paper is to develop a macroeconomic model for a small open developing economy that borrows abroad. This model will assist in studying the dynamic interaction between debt and growth, as well as the impact of various policies and exogenous shocks on the rate of capital accumulation, the current account and debt. From this analysis, the authors make the following conclusions. An upward shift in the supply of debt leads to a long run decline in external debt, a higher domestic interest rate, less capital stock, and a reduced trade surplus. An increase in the marginal cost of debt may or may not lower long run external debt as well. An increase in productivity raises the long run stock of capital but leaves the level of external debt and the interest rate unchanged in the long run. Finally, fiscal expansion has almost no effect in either the short run or the long run.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 260.

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Date of creation: 31 Aug 1989
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Handle: RePEc:wbk:wbrwps:260
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  1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  2. Willem H. Buiter, 1984. "Fiscal policy in open, interdependent economies," NBER Working Papers 1429, National Bureau of Economic Research, Inc.
  3. Maurice Obstfeld, 1981. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," NBER Working Papers 0686, National Bureau of Economic Research, Inc.
  4. Brock, Philip L., 1988. "Investment, the current account, and the relative price of non-traded goods in a small open economy," Journal of International Economics, Elsevier, vol. 24(3-4), pages 235-253, May.
  5. Calvo, Guillermo A., 1987. "Real exchange rate dynamics with nominal parities Structural change and overshooting," Journal of International Economics, Elsevier, vol. 22(1-2), pages 141-155, February.
  6. Eaton, Jonathan & Gersovitz, Mark, 1980. "LDC participation in international financial markets : Debt and reserves," Journal of Development Economics, Elsevier, vol. 7(1), pages 3-21, February.
  7. Turnovsky, S. & Sen, P., 1988. "Deterioration Of The Term Of Trade And Capital Eccumulation A Reexamination Of The Laursen-Metzler Effect," Working Papers 88-08, University of Washington, Department of Economics.
  8. Sen, Partha & Turnovsky, Stephen J., 1989. "Deterioration of the terms of trade and capital accumulation: A re-examination of the Laursen-Metzler effect," Journal of International Economics, Elsevier, vol. 26(3-4), pages 227-250, May.
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