Voluntary Debt Reduction: Incentives and Welfare

Elhanan Helpman

IMF Staff Papers, 1989, vol. 36, issue 3, 580-611

Abstract: In an economy with a debt overhang, investment depends on expected tax rates, but expected tax rates depend on the debt's face value. Therefore investment depends on the face value of debt. This relationship may lead to a positive or negative association between debt and investment. The paper explores the desirability of debt reduction. First, it characterizes circumstances in which debt reduction is desirable from the collective point of view of the creditors. Second, it formulates the forgiveness decision as a noncooperative game among creditors and explores the scope for debt reduction as an outcome of this game.

Date: 1989
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