Growth in Spasmodia: Foreign Borrowing and Crisis

Raul Fabella

No 198404, UP School of Economics Discussion Papers from University of the Philippines School of Economics

Abstract: We construct a dynamic decision model where foreign borrowing figures as one of the instruments to maximize welfare over a planning horizon. We hypothesize a relation, a rather reasonable one, between the repayment schedule and the debt ceiling. For every period, there exists an optimal per capita debt, which together with the optimal consumption path leads in a sustainable fashion to maximal long-run welfare. In the short run, however, one can actually to better by borrowing exceeding the optimal debt but this path leads for a balance of payments crisis as the debt catches up with the ceiling. The economy goes into a spasm as it resorts to drastic measures. A regime with short memory may mount yet another assault on the debt ceiling and suffer the same fate. Myopia leads to a dismal long-run growth record.

Date: 1984-04
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Published as UPSE Discussion Paper No. 1984-04, April 1984

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