Sovereign Debt Relief Schemes and Welfare

This paper shows that concerted debt reduction may be welfare-improving even when the investment disincentive effect of a debt overhang is not large enough to place the debtor country on the wrong side of the debt Laffer curve. Whether the appropriate relief scheme involves debt reduction or new money, however, depends on whether investment disincentives or liquidity constraints dominate. It is shown that, except under very special circumstances, mixed policy packages involving both debt and liquidity relief may not yield the desired results.Debt relief;Debt reduction;Economic models;debt, creditor, debt overhang, debtor country, repayment, debt obligations, external debt, consumption tax, debt crisis, debt burden, obligations, debt forgiveness, debtor countries, debtor government, sovereign debt, payments, restructuring, debt renegotiations, creditors, debt servicing, debt restructuring, debt buyback, indebted countries, debt negotiations, stock of debt, debt problems, heavily indebted countries, debtors, repurchases, repayment capacity, repayments, solvency, official creditors, net debt, relief package, market debt, sovereign debtors, taxes, interest, debt obligation, debt repayment, debt-equity, loans, external debt negotiations, debt exchange