DP6024 Loans or Grants

Author(s): Daniel Cohen, Pierre Jacquet, Helmut Reisen
Publication Date: January 2007
Keyword(s): developing countries, grants, loans
JEL(s): O19
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6024

We argue in this paper that cancelling the debt of the poorest countries was a good thing, but that it should not imply that the debt instrument should be foregone. We claim that debt and debt cancellations are indeed two complementary instruments which, if properly managed, perform better than either loans or grants taken in isolation. The core of the intuition, which we develop in a simple two-period model, relates to the fact that the poorest countries are also the most volatile, so that contingent facilities, explicitly incorporating debt cancellation mechanisms, are a valuable instrument. Based on this idea, we present one of the lending scheme that could be applied to the poorest countries and calibrate the cost that would have to be borne by the creditors, were they to incorporate contingencies clause in their lending strategy.