OECD Development Centre Working Papers

ISSN :
1815-1949 (online)
DOI :
10.1787/18151949
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The OECD Development Centre links OECD members with developing and emerging economies and fosters debate and discussion to seek creative policy solutions to emerging global issues and development challenges. This series of working papers is intended to disseminate the OECD Development Centre’s research findings rapidly among specialists in the field concerned. These papers are generally available in the original English or French, with a summary in the other language.
 

Debt Overhang, Liquidity Constraints and Adjustment Incentives You or your institution have access to this content

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Author(s):
Bert Hofman, Helmut Reisen
Publication Date
01 Oct 1990
Bibliographic information
No.:
32
Pages
33
DOI
10.1787/356147450736

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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 ...