What Does Debt Relief Do for Development?

What Does Debt Relief Do for Development?

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High levels of household debt are a common problem in developed and developing economies, and evidence from the global financial crisis suggests that high household debt-to-GDP ratios can be an important source of financial instability, prolonged recessions, and reduced income growth in the longer run. In the aftermath of the financial crisis, policymakers have therefore sought to identify policies that can effectively reduce household debt, and direct credit market interventions—such as debt moratoria or debt relief for highly-indebted households—have been proposed as a potential solution. Such programs have, however, remained controversial because there is limited evidence on their ability to resolve debt overhang and stimulate economic activity, and because critics worry that debt forgiveness may generate moral hazard on the part of banks and borrowers and do lasting damage to a culture of prudent borrowing and repayment.

In this policy research talk, economist Martin Kanz will provide new perspectives on these issues based on a set of recent research papers in which he examines the impact of one of the largest borrower bailouts in history, enacted by the government of India against the backdrop of the 2008-2009 global financial crisis. Based on the findings of this work, the talk will explore the impact of debt relief from three angles: First, what is the immediate impact of debt forgiveness on beneficiary households? In particular, is there evidence that the bailout resolved debt overhang, restored access to credit, and had a positive effect on investment and real economic activity? Second, what is the impact of debt forgiveness on borrower moral hazard, credit allocation, and the risk-taking behavior of banks? Third, what are the political economy effects of debt relief, how was the bailout perceived by voters, and how might this compromise the optimal design of credit market interventions in the future?

The presentation will relate these findings to recent work on household debt and macroeconomic stability, as well as the ongoing debate on debt relief for HIPC countries. 

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