Working Paper: NBER ID: w2655
Authors: Dani Rodrik
Abstract: This paper analyzes some of the implications of the dual transfer a debtor nation must undertake to service foreign debt: (a) an internal transfer from the private sector to the public sector; and (b) an external transfer from the domestic economy to foreign creditors. It shows that, under likely circumstances, a real depreciation of the home currency may complicate the internal transfer. As long as non-traded goods are a net source of revenue for the government, the depreciation called for by debt service deteriorates the public sector's terms of trade vis-a-vis the private sector and magnifies the requisite fiscal retrenchment. The paper discusses the role of trade policy (tariffs and export subsidies) in substituting for devaluation. Generating a private-sector surplus via interest-rate policy is shown to have similar costs on the government budget when the public sector has outstanding domestic debt.
Keywords: debt service; welfare economics; fiscal policy; exchange rates; trade policy
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt service (H63) | internal transfer from the private sector to the public sector (J45) |
| internal transfer from the private sector to the public sector (J45) | deterioration in public sector's terms of trade relative to the private sector (J45) |
| real depreciation of currency (F31) | complicates internal transfers (F16) |
| real depreciation of currency (F31) | exacerbates burden of debt service (F34) |
| devaluation (F31) | negated by inflation or capital flight (F32) |
| failure to manage exchange rate policies (F31) | adverse outcomes (capital flight or increased inflation) (F32) |
| servicing foreign debt (F34) | social inefficiencies (increased taxes or decreased public spending on social equity) (H29) |