Can Output Losses Following International Financial Crises Be Avoided?

Abstract

Recent financial crises in emerging markets have been followed by temporary but substantial losses in output. This paper explores the possibility that threats of such losses are the dominant incentive for repayment of international debt. In this environment private debtors and creditors have strong incentives to design international contracts so that renegotiation is costly. Such contracts generate dead weight losses and proposals for reform of the international monetary system that modify explicit and implicit contractual arrangements and can be welfare improving under special circumstances. However, such proposals might also weaken the incentives that make private international debt possible.