Market-Based Debt-Reduction Schemes

Paul Krugman

No 2587, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Recently much attention has been given to the idea of reducing the debt of developing countries through a "menu approach" of schemes that attempt to harness the discounts on debt in the secondary market. This paper, after reviewing the rationale for the orthodox strategy of concerted lending and the case for debt forgiveness, examines the logic behind several market-based debt reduction schemes. It shows that such schemes will ordinarily benefit both debtor and creditor only when the debtor is on the wrong side of the "debt relief Laffer curve" -- that is, where a reduction in nominal claims actually increases expected payment. This is, however, also the case in which unilateral debt forgiveness is in the interest of creditors in any case. The implication is that there is no magic in market-based debt reduction, as opposed to more straightforward approaches.

Date: 1988-05
Note: ITI IFM
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Published as Analytical Issues in Debt, edited by Jacob A. Frenkel, Michael P. Dooley,and Peter Wickham, pp. 258-278. Washington, DC: International Monetary Fund, 1989.

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