Optimal Adjustment Policy and Debt-Restructuring Under Asymmetric Information

Abstract

With some probabiity a country will find it infeasible to honor its international obligations. If the probabiity distribution of that feasibiity depends on unobservable aspects of the country's economic policy, the moral hazard present requires the imposition of an incentive-compatibility constraint on the design of debt-restructuring agreements. In this paper we discuss the implications of such a constraint for the design of a Pareto-optimal agreement.