Sources of Debt Accumulation in a Small Open Economy
IMF Working Papers, October 1, 1997
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- Sources of Debt Accumulation in a Small Open Economy
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Bibliographic details
- Authors: Abdelhak S Senhadji
- Published: October 1, 1997
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451856606.001
Research question and context
- Analyzes the borrowing behavior of a small open economy of a developing country that:
- relies heavily on imports for its capital formation;
- faces an upward-sloping supply function of foreign loans.
- Decision makers in the model face uncertainty about the longevity of external shocks, generating forecast errors that affect borrowing.
Core findings
- Uncertainty about the persistence (longevity) of external shocks generates forecast errors that lead to substantial debt accumulation.
- Modeling the foreign loan market with an upward-sloping supply function (rather than the usual perfectly elastic supply) provides a more realistic formulation for developing countries.
- The upward-sloping supply function offers an alternative to the Uzawa-type utility function for analyzing asset accumulation within the small open economy framework.
Methodology and model features
- Framework: small open economy model for a developing country.
- Key model ingredients:
- Heavy reliance on imports for capital formation.
- Upward-sloping supply function of foreign loans.
- Uncertainty regarding the duration of external shocks (incomplete information).
- Use of a Stochastic Dynamic General Equilibrium Model (implied by keywords).
Policy-relevant implications
- Recognition that imperfectly elastic access to foreign loans can be an important driver of external debt dynamics in developing countries.
- Attention to information and forecasting about external shocks is critical: forecast errors about shock persistence can materially increase debt accumulation.
- Modeling choices about the foreign loan supply curve (upward-sloping vs. perfectly elastic) materially affect analysis of debt dynamics and may imply different policy responses to external shocks and borrowing.
Content in this bundle
- Souces of Debt Accumulation in a Small Open Economy - WP/97/146