Part III.
Macroeconomics and Small Developing Economies: A Policy-Maker’s Perspective. (Section 5, External Debt ) PP. 111-112 By DeLisle Worrell.
In Economics in a Changing World. Edited by Edmar L. Bacha
Issues of major concern in the macroeconomic literature on external debt are the optimal level of debt and the risk of debt repudiation. The optimum rate of debt accumulation is determined by the growth rate and the real interest rate. The faster the growth rate of a competitive economy the greater is its capacity to service external debt. The more rapidly an economy grows the more external debt it may support, for any level of the interest rate.
In the open economy the real interest rate is exogenous, determined on the international capital market. The rate of debt accumulation therefore depends on the growth rate. If the growth rate is exogenous, as it is in many models of debt accumulation, there is a maximum sustainable rate of debt accumulation. Models where growth depends on savings encourage the notion of an external debt constraint on growth, because an increase in interest rates reduces the optimal rate of external debt accumulation and therefore the resources available for growth. However, this implies that the increase in domestic finance in response to the increase in real interest rates is not sufficient to compensate for the reduction in external borrowing.
In models of endogenous growth it becomes clear that external debt accumulation is not the constraint, though real interest rates may be. The rate of growth depends on investment-promoting policies such as macroeconomic stability, trade policy, tax policy and the provision of public goods. For any rate of growth the real interest rate determines the ratio of external to domestic finance. If there is an external constraint on growth it is the real interest rate, which may reduce the level of investment, ceteris paribus.
One may assess the risk of default on external debt by comparing the cost of economic adjustment to provide surpluses for debt servicing with the costs of debt repudiation (Ghatak and Levine, 1991). These models are helpful in understanding the evolution and treatment of debt in the recent past, but they are less useful in determining future strategy because the results depend critically on parameters such as the rate of time preference of borrowers and the degree of risk aversion of lenders, which can only be guessed at.
The author states that:
Item 1 -
Part III.
Macroeconomics and Small Developing Economies: A Policy-Maker’s Perspective. (Section 5, External Debt ) PP. 111-112 By DeLisle Worrell.
In Economics in a Changing World. Edited by Edmar L. Bacha
Issues of major concern in the macroeconomic literature on external debt are the optimal level of debt and the risk of debt repudiation. The optimum rate of debt accumulation is determined by the growth rate and the real interest rate. The faster the growth rate of a competitive economy the greater is its capacity to service external debt. The more rapidly an economy grows the more external debt it may support, for any level of the interest rate.
In the open economy the real interest rate is exogenous, determined on the international capital market. The rate of debt accumulation therefore depends on the growth rate. If the growth rate is exogenous, as it is in many models of debt accumulation, there is a maximum sustainable rate of debt accumulation. Models where growth depends on savings encourage the notion of an external debt constraint on growth, because an increase in interest rates reduces the optimal rate of external debt accumulation and therefore the resources available for growth. However, this implies that the increase in domestic finance in response to the increase in real interest rates is not sufficient to compensate for the reduction in external borrowing.
In models of endogenous growth it becomes clear that external debt accumulation is not the constraint, though real interest rates may be. The rate of growth depends on investment-promoting policies such as macroeconomic stability, trade policy, tax policy and the provision of public goods. For any rate of growth the real interest rate determines the ratio of external to domestic finance. If there is an external constraint on growth it is the real interest rate, which may reduce the level of investment, ceteris paribus.
One may assess the risk of default on external debt by comparing the cost of economic adjustment to provide surpluses for debt servicing with the costs of debt repudiation (Ghatak and Levine, 1991). These models are helpful in understanding the evolution and treatment of debt in the recent past, but they are less useful in determining future strategy because the results depend critically on parameters such as the rate of time preference of borrowers and the degree of risk aversion of lenders, which can only be guessed at.
The author states that:
Item 1- in models of endogenous growth, for any rate of growth the real interest rate determines the ratio of external to domestic finance.
