Missing Link: Volatility and the Debt Intolerance Paradox

Author/Editor:

Luis Catão ; Sandeep Kapur

Publication Date:

March 1, 2004

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

A striking feature of sovereign lending is that many countries with moderate debt-to-income ratios systematically face higher spreads and more stringent borrowing constraints than others with far higher debt ratios. Earlier research has rationalized the phenomenon in terms of sovereign reputation and countries' distinct credit histories. This paper provides theoretical and empirical evidence to show that differences in underlying macroeconomic volatility are key. While volatility increases the need for international borrowing to help smooth domestic consumption, the ability to borrow is constrained by the higher default risk that volatility engenders.

Series:

Working Paper No. 2004/051

Subject:

Consumption Debt burden Debt default Income Public debt

English

Publication Date:

March 1, 2004

ISBN/ISSN:

9781451847147/1018-5941

Stock No:

WPIEA0512004

Pages:

34

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