The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
This paper constructs and analyzes an optimizing model of a highly-indebted small open economy. An important innovation in the model is the incorporation of sovereign risk through the specification of an upward-sloping foreign debt supply function. The model is used to examine the interaction between external debt and growth in response to various policies and exogenous disturbances. It is shown that structural policies intended to reduce the fiscal deficit or increase productivity can lead to tradeoffs in their effect on capital accumulation and the stock of debt.