Working Paper: NBER ID: w2541
Authors: Kenneth A. Froot; David Scharfstein; Jeremy Stein
Abstract: We compare different indexation schemes in terms of their ability to facilitate forgiveness and reduce the investment disincentives associated with the large LDC debt overhang. Indexing to an endogenous variable (e.g., a country's output) has a negative moral hazard effect on investment, This problem does not arise when payments are linked to an exogenous variable such as commodity prices. Nonetheless, indexing payments to output may be useful when debtors know more about their willingness to invest than lenders. We also reach new conclusions about the desirability of default penalties under asymmetric information.
Keywords: LDC debt; debt forgiveness; investment incentives; indexation schemes; moral hazard
JEL Codes: F34; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Debt repayments linked to a country's output (F34) | Reduced investment incentives (G31) |
| Debt repayments linked to a country's output (F34) | Moral hazard (G52) |
| Linking debt repayments to an exogenous variable (F34) | First-best level of investment (G11) |
| Output indexation (C43) | Facilitation of debt restructuring (G33) |
| High penalties for delinquent borrowers (G21) | Lower average investment levels (G19) |
| High penalties for delinquent borrowers (G21) | Lower overall welfare (D69) |
| Debt repayments linked to a country's output (F34) | Higher debt obligations (G32) |