Debt Overhang, Liquidity Constraints and Adjustment Incentives

Investment in most heavily indebted countries has been weak since 1982. The widely accepted debt overhang proposition interprets the investment drop as a moral hazard problem: a heavy debt burden raises the incentive to consume, because the marginal benefit of investment would go to the creditor. Th...

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Bibliographic Details
Main Author: Hofman, Bert
Other Authors: Reisen, Helmut
Format: eBook
Language:English
Published: Paris OECD Publishing 1990
Series:OECD Development Centre Working Papers
Subjects:
Online Access:
Collection: OECD Books and Papers - Collection details see MPG.ReNa
Description
Summary:Investment in most heavily indebted countries has been weak since 1982. The widely accepted debt overhang proposition interprets the investment drop as a moral hazard problem: a heavy debt burden raises the incentive to consume, because the marginal benefit of investment would go to the creditor. This paper develops several hypotheses on optimal reactions of a credit-constrained debtor country on an increase in debt, on variations in the credit constraint, on changes in interest rates, and contrasts these with the predictions stemming from the debt overhang proposition. Empirical specifications of conventional investment functions and consumption functions (along the Permanent Income Hypothesis) lead to reject the debt overhang proposition, but find that the switch from positive to negative external transfers to the debtor countries is an important explanation for their investment drop. The major policy conclusion is that the 1989 shift in international debt management (the Brady ...
Physical Description:33 p. 21 x 29.7cm