## Sources of Debt Accumulation in a Small Open Economy

_IMF Working Papers, October 1, 1997_

## Source details

**Canonical URL:** [Sources of Debt Accumulation in a Small Open Economy](https://www.imf.org/en/publications/wp/issues/2016/12/30/sources-of-debt-accumulation-in-a-small-open-economy-2371)

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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

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### 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.

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## Content in this bundle

- **Souces of Debt Accumulation in a Small Open Economy - WP/97/146**
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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/sources-of-debt-accumulation-in-a-small-open-economy-2371_