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Debt Forgiveness: The Case for Hyper-Incentive Contracts

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  • Gordon  Menzies

Abstract

We review two proposals for debt forgiveness; the Highly Indebted Poor Country Initiative (HIPC) and the Jubilee 2000 Coalition Initiative (J2K). We then consider the workhorse model of debt forgiveness (Krugman 1988). We show that the workhorse model solution is a sub-optimal contract, where the incentive parameter is set without regard to the cost of effort. A fully-optimal debt-overhang contract is derived, with an incentive parameter greater than the marginal social benefit of extra effort. The so-named Hyper-Incentive Contract eliminates the effects of moral hazard arising from hidden effort, and provides a fuller rationale for case-by-case debt-overhang contracts.

Suggested Citation

  • Gordon  Menzies, 2000. "Debt Forgiveness: The Case for Hyper-Incentive Contracts," Economics Series Working Papers 37, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:37
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    1. Calvo, Guillermo A. & Kaminsky, Graciela L., 1991. "Debt relief and debt rescheduling : The optimal-contract approach," Journal of Development Economics, Elsevier, vol. 36(1), pages 5-36, July.
    2. McDonald, Ian M & Solow, Robert M, 1981. "Wage Bargaining and Employment," American Economic Review, American Economic Association, vol. 71(5), pages 896-908, December.
    3. Cole, Harold L & Kehoe, Patrick J, 1998. "Models of Sovereign Debt: Partial versus General Reputations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 55-70, February.
    4. Huw Evans, 1999. "Debt Relief for the Poorest Countries: Why Did It Take So Long?," Development Policy Review, Overseas Development Institute, vol. 17(3), pages 267-279, September.
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    1. repec:dau:papers:123456789/4089 is not listed on IDEAS
    2. Michaelowa, Katharina, 2003. "The Political Economy of the Enhanced HIPC-Initiative," Public Choice, Springer, vol. 114(3-4), pages 461-476, March.

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    More about this item

    Keywords

    debt overhang; debt forgiveness; optimal contracts; moral hazard;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F35 - International Economics - - International Finance - - - Foreign Aid

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