(DP 1984-04) Growth in Spasmodia: Foreign Borrowing and Crisis

Abstract

We construct a dynamic decision model where foreign borrowing figures as one of the instruments to maximize welfare over a planning horizon. We hypothesize a relation, a rather reasonable one, between the repayment schedule and the debt ceiling. For every period, there exists an optimal per capita debt, which together with the optimal consumption path leads in a sustainable fashion to maximal long-run welfare. In the short run, however, one can actually to better by borrowing exceeding the optimal debt but this path leads for a balance of payments crisis as the debt catches up with the ceiling. The economy goes into a spasm as it resorts to drastic measures. A regime with short memory may mount yet another assault on the debt ceiling and suffer the same fate. Myopia leads to a dismal long-run growth record.