We introduce long-term debt (and a maturity choice) into a standard model of firm financing and investment. This allows us to study two distortions of investment: (1.) Debt dilution distorts firms' choice of debt which has an indirect effect on investment; (2.) Debt overhang directly distorts investment. In a dynamic model of investment, leverage, and debt maturity, we show that the two frictions interact to reduce investment, increase leverage, and increase the default rate. We provide empirical evidence from U.S. firms that is consistent with the model predictions. Using our model, we isolate and quantify the effect of debt dilution and debt overhang. Debt dilution is more important for firm value than debt overhang. Debt overhang can actually increase firm value by reducing debt dilution. The negative effect of debt dilution on investment is about half as strong as that of debt overhang. Eliminating the two distortions leads to an increase in investment equivalent to a reduction in the corporate income tax of 3.5 percentage points. ; The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
After the huge debt increases in the 1940s, due to the WWII, and in the 1980s due to the emerging markets' debt crises, the debt overhang problem is once again at the center of the academic and political debate because of the recent debt crisis that affected the European countries in 2009. The debt overhang theory explains how an high level of debt distorts the optimal investment decisions and reduces government's incentives, in the debtor country, to undertake the necessary "adjustment policies". A huge literature focuses on the negative effects deriving from a debt overhang condition. In particular, this kind of literature has been mostly used to describe and to study poor and less developed countries. Nowadays instead, the situation is quite different with the Greek case that represents a very peculiar and never experienced situation. Chapter 1 of the thesis starts with an introduction of the sovereign debt overhang problem. Then, since the aim is to study the possible policy interventions able to solve it, the focus is posed on sovereign debt restructuring as a resolution mechanism. A relief intervention can be considered, indeed, as a way to reduce the debt burden for a country struggling with an high level of debt. Descriptions of the restructuring process, of the macroeconomic consequences and of the Greek case are then provided in this chapter in addition to some stylised facts and an event analysis useful to communicate the main messages. In the past, several different strategies of debt restructuring have been implemented and the consequences they produced were often different case by case. It is then interesting to study the effectiveness of the several options that can be used to restructure public debt. For this reason, a very simple theoretical model is developed in Chapter 2 in order to study three different strategies that can be used to solve a sovereign debt overhang problem. In particular, two strategies are based on a debt restructuring process, via face value reduction or rescheduling, whereas a third one is based on conditional-additional official lending. This strategy relies on the idea that the debtor country can benefit of new lending from the official sector, in order to undertake a larger amount of investment. The aim of the model is to represent schematically the functioning of the three restructuring processes to gain insights into their differences and to study their consequences in term of incentives to invest in a "troubled country". An empirical evidence of the debt overhang hypothesis is then provided in Chapter 3. The combination of the sovereign debt crisis of 2009 and the fiscal consolidation policies implemented as a result, makes indeed interesting to study this hypothesis in Europe. The Chapter exploits then a panel dataset for the European countries, between 1995 and 2015, in order to examine the extent to which increased levels of public debt have led to reduced public investment. We start the analysis from basic POLS models and then we expand it gradually to FE, IV and GMM estimation models. The results validate the debt overhang hypothesis and remain robust across various model specifications.
Is the seniority structure of sovereign debt neutral for a government's decision between defaulting and raising surpluses? In this paper, we address this question using a model of debt crises where a discretionary government endogenously chooses distortionary taxation and whether to apply an optimal haircut to bondholders. We show that when the size of senior tranches is small, a version of the Modigliani-Miller theorem holds: tranching just redistributes government revenues from junior to senior bondholders, while taxes and government borrowing costs remain unchanged. However, as senior tranches become sufficiently large, default costs on senior debt transpire into a stronger commitment to repay not only the senior tranche, but also the junior one. We show that there is a lower threshold for senior bonds above which tranching can eliminate default on both junior and senior debt, and an upper threshold beyond which the government defaults also on senior debt. ; The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
Indonesia has received external debt as an external source of finance to fill in the investment-saving gap in achieving economic growth to improve social welfare. Despite Indonesian economy is able to recover to some extent, based on Bank Indonesia (2018), Indonesia's external debt at the end of Q2/2018 still amounted to USD 355,7 billion; consisting of government and central bank external debt of USD 179.7 billion, as well as private sector (including state-owned enterprises) external debt of USD 176.0 billion. Therefore, this study aims to examine the trend and impact of external debt on economic growth in the context of Indonesia's economy. If external debt is found to lead to debt trap, or already in the condition of growth-led debt, its benefits for economic development should be reviewed properly and government policies regarding external debt need to be redesigned. This study is a qualitative research in the form of case study of External Debt and its critical impact in Indonesia. Through observation, data comparison and literature study, it is found that external debt of Indonesia has been dominated by US Dollar and Japanese Yen, which assumed to cause surge in debt repayment.
The Great Recession has sent debt levels to a post-WWII high for several advanced economies, reviving the discussion of fiscal consolidation. This paper assesses the macroeconomic implications of tax-based versus spending-based consolidation within the framework of a New Keynesian model with long term government debt. Three results stand out: First, tax-based consolidations are inflationary whereas spending-based ones are deflationary. Second, the net benefits of inflation increase in the average maturity of outstanding debt: inflation revalues debt more efficiently, while distortions due to price dispersion remain unaffected - the maturity effect. Third, as a result, tax-based consolidations can become superior to spending cuts if the average maturity is high enough. Quantitatively, the threshold is two years for US data in 2013. The previous mechanism illustrates the importance of inflation in the consolidation process, even if raising its target rate is considered not to be an option.
We study debt mutualisation in the Euro area. Bearing in mind other existing proposals we provide an alternative Blue, Yellow and Red Bonds proposal: blue, would cover debt up to 60% of GDP, yellow would include debt from 60% up to 90% of GDP, and red would cover debt above 90% of GDP. Although not with joint liability, the rationale behind the Yellow Bonds with a joint issuance is the attraction of liquidity, which would be beneficial, especially for the countries with high yields. This could give more room to public authorities.
In June 2019, the Constitutional Council of Mozambique delivered a judgment declaring a financial transaction arranged by the government in violation of the parliamentary prerogatives in budgetary matters unconstitutional. This was only the tip of an iceberg consisting of a series of transactions tainted with corruption. In the face of this illegality, many antidebt campaigners have invoked the application of the odious debt doctrine to block the enforcement of contractual claims and the availability of restitutionary remedies. Under the odious debt doctrine, a debt is odious if, in the awareness of the creditors, it is contracted without the consent of and not for the benefit of the population. The operation of the odious debt doctrine presupposes an inquiry into its legal status. Lacking a proper normative characterization, the doctrine is to be understood more as a matter of policy than as a matter of law. As a result, its ideal systematic placement would be under the umbrella of transnational public policy. Transnational public policy establishes universal principles to serve the common interests of mankind. The key point, then, is to ascertain whether and to what extent the values enshrined into the odious debt doctrine may belong to the realm of the transnational public policy. In this context, the controversy on the validity of the Mozambican debt can become the touchstone for testing the legal status and operation of the odious debt doctrine.
A letter report issued by the General Accounting Office with an abstract that begins "This report discusses the Treasury Department's debt management strategies in a period of budget surplus. As the level of debt held by the public has decreased, the Treasury has had to rethink its strategies for best achieving its three goals--having enough cash on hand, minimizing cost over time, and promoting efficient markets. The Treasury has used existing and new debt managing tools in response to the challenges posed by declining debt. In calendar year 2000, the Treasury began two new programs designed to improve market liquidity: regularly reopening existing debt issues rather than creating new issues, and conducting buybacks of about $30 billion in longer-term bonds before they matured, thereby enabling the Treasury to issue more new securities. In addition, higher issuance levels of short-term bills were made possible by eliminating longer-term notes. Capital markets have been adjusting to the reduced supply of Treasury securities. For example, capital market participants have begun using financial instruments other than Treasury securities as pricing tools for transactions. If projected budget surpluses materialize, the current combination of debt auction schedules, issue sizes, and maturities will be unsustainable over the next several years."
International audience ; The political and economic crisis in Europe is often viewed as an indirect consequence of the global financial and economic breakdowns caused by the US "subprime" crisis. European governments themselves tend to underestimate Europe's responsibility for the crisis and seem to prefer to manage the symptoms of the crisis rather than pursue a real recovery from it. This paper argues that the enforced policies are far from achieving an appropriate economic solution for the Eurozone. Moreover, it suggests that, although the European domestic debt situation is very close to the American one, their most recent evolutions and their main causes differ. If the growth of the American debt can partly be explained by macroeconomics imbalances, the causes of the growth of the European domestic debt must be found in a change in the behavior of the financial sector agents. The conclusion advocates for a more radical European policy to solve the debt bubble. ; La crise européenne est souvent perçue comme le produit indirect de la crise financière et de la récession mondiale causée par l'éclatement de la crise des "subprimes" américaine. Les gouvernements européens eux-mêmes tendent à sous-estimer les responsabilités des européens dans la crise et préfèrent en gérer les symptômes plutôt que de travailler à un redressement en profondeur. Dans cet article nous montrons que les politiques mises en œuvre ne peuvent être considérées comme des solutions appropriées à la situation économique. D'autre part, nous suggérons que bien que les niveaux des dettes domestiques européennes et américaines sont proches, leurs causes et leurs évolutions récentes sont différentes. Si l'accroissement de la dette américaine peut s'expliquer par des déséquilibres macroéconomiques, l'augmentation de la dette européenne ne peut s'expliquer que part des changements comportementaux des acteurs du secteur financier. En conclusion nous proposons de mettre en œuvre des solutions plus radicales pour mettre fin à la bulle du crédit.
International audience ; The political and economic crisis in Europe is often viewed as an indirect consequence of the global financial and economic breakdowns caused by the US "subprime" crisis. European governments themselves tend to underestimate Europe's responsibility for the crisis and seem to prefer to manage the symptoms of the crisis rather than pursue a real recovery from it. This paper argues that the enforced policies are far from achieving an appropriate economic solution for the Eurozone. Moreover, it suggests that, although the European domestic debt situation is very close to the American one, their most recent evolutions and their main causes differ. If the growth of the American debt can partly be explained by macroeconomics imbalances, the causes of the growth of the European domestic debt must be found in a change in the behavior of the financial sector agents. The conclusion advocates for a more radical European policy to solve the debt bubble. ; La crise européenne est souvent perçue comme le produit indirect de la crise financière et de la récession mondiale causée par l'éclatement de la crise des "subprimes" américaine. Les gouvernements européens eux-mêmes tendent à sous-estimer les responsabilités des européens dans la crise et préfèrent en gérer les symptômes plutôt que de travailler à un redressement en profondeur. Dans cet article nous montrons que les politiques mises en œuvre ne peuvent être considérées comme des solutions appropriées à la situation économique. D'autre part, nous suggérons que bien que les niveaux des dettes domestiques européennes et américaines sont proches, leurs causes et leurs évolutions récentes sont différentes. Si l'accroissement de la dette américaine peut s'expliquer par des déséquilibres macroéconomiques, l'augmentation de la dette européenne ne peut s'expliquer que part des changements comportementaux des acteurs du secteur financier. En conclusion nous proposons de mettre en œuvre des solutions plus radicales pour mettre fin à la bulle du crédit.
Many analysts argue that trade sanctions are ineffective because they generate incentives for evasion. Others object to them as hurting the population of the target country as much as its leaders. We argue that loan sanctions unlike trade sanctions may be self-enforcing, and that they help the population by protecting it from being saddled with "odious debt" run up by dictators to finance looting or repression. In particular, governments could impose sanctions by instituting legal changes that prevent seizure of a country's assets for non-repayment of debt, if the debt was incurred after the sanction was imposed. This would reduce creditors' incentive to extend loans to sanctioned regimes. However, decisions on whether assets can be seized to enforce debt repayment would be subject to bias if they were made ex post and the deciding body asymmetrically valued the welfare of debtor countries and their creditors. Restricting such decisions to cover only future lending would help avoid this time-consistency problem.