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Irrstitut fiir l{cltwirtschaft
2300 Kiel, Diisternbrooker Weg 120

Kicl Working Papcr No. 347

THE HALF NND THE FULL DEBT CYCLE

by
Horst Siebert
t,.
Januar 1989

.dr
,\\'tqir
ar6'*
Januar 1989 FO
Jhe authors thcnrselves, not thc Kiel Institute of l{orld Economics, are
colcly reeponsible for the contents and distribution of cach Kicl t{orking
Paper.
since the series involves manuscripts in a preliminary form, interested
rcaders-arc requ€sted to dircct criticisms ind suggistione dirccrly to
thc euthors and to clear any quotationc with thcm.
ISSN 0{32-0?87
 I
It--
t The Ralf and the Full Debt Cycle
i
I
Hors t S iebertr

A country nay incur debt in order to build up capital

and in order
to atlor earlier consuuption. I
rors both for consunption and
incrcaseg- initiarry and ie reduced eventually, but the countrv
aeEal'g a deD
- --:;-.tor. - In
for " t]_l_3g!:_SJ.gle, however, a counrry borrows
---- capital accunulntinn nsIy. Low consuuption ,l*II-i;;i"f
p"% capitar *Tlll,"iiillt
rt.ht beiog
debt h-i^, repaid,
-^--ri lffi-- "".ffillGil
the debtor countty b."o""" "na
a creditlll

The concept of the debt cycre has been presented

in an intuitive
fsghion in thc lite.ature, foi instance in the riorrd Developnent
R.port of l9B5 (ltorld Bank 198S, p, 47) qnd
by Kindleberger
(1968). A countrv changes frou a young through
a nature debtor and
a debt rcducer until eventually becooing a young
and .a ,ature
creditor. The atages of debt and asseta, horever, arG
not dorivo.
in a fornal rodcl.

In thia paper, *e present such a nodel of the

cyclical behavior of
debt and no crtablish conditions for a half
and a full debt cyclc.
APJ=*IIiv' in a half debt cyqle, the problen of
.
prevrlcnt rh rncrcar
dcfault il;ore
"
---- --- in
-'. a
u full
rs.r debt
uruL cycle,
cycle, thc problcr of indcbled-
Der3 ir rolvcd over tine in s naturol sort
of way. Elphasie is put
on tha derivrtion of thc tiue profile of debt and of thc
balancc
of pryrcntr. r )

rn 'rection r' the oodel ie rpecified. Thc half

-
tirc profilec of debt, conrurption and thc
debt cvcle rith the
balance of payrcnt ir
dircuared in rection II' Thc intertenporal propcrties
of thc full
dcbt cyclc rrc analyzcd in gcction IIr. !listorical
exarplcc of thc
half and of lhe full debt cyclc are givcn in section IV. Einally
aoar conditior! arc apecifi.d thst oay lalc
a full dcbt cyclc rorc
likcly.
 ? 3
I. The I'19,!9J For fini te t iEe, we have aa a trangvergaLity condition

K (T) - I (T) ZK (5)

Sxcopt for tho trunrvot'nolit.y conditlon, Hc ufc thn rodol npoci-
fied in Siebert ( 198?, p. 6lS). The country Eaxinizec the presont
i{here X (T) and I (T) are the atock
capital and of debt, re-
value of utility for a planning period [0, T] with a given terri- _of
nal tine T rpcctively, in terrinal tine T and l( is the capital ctock to bc
handcd over to future generation" uffi"
T ihat deht hag to be repaid in terninal tiDe, For sioplicity, it i
, =oJ . - r! li(c) dt (l) asauded thst the capital stock to be handed over to future
generatiqns, tr, K',
being defined by
where C is conguuption and 6 j,s a given tine preference rate. As
Fx (K') - o = r. (5a)
restraints ve have a production functron
For infinite tinc, it does not rako gcnse to requirc that debt ir
o = r(x) (2) repaid. It ir lore convincing that, in thc linit, intcreet on thr
stock of debt nust not exceed net national product:
with Q dcnoting output.nd X thr crPitel rtock. Both thr utllity
and the production function havc thc uruel propcrti.t. lir Ir E (t)] s Iin (r (x (t)) nx (t)I (6)
t.o tro
The capital gtock chan8or by groas invca.!;1cnt I and th. dcprecir-
tion of the capital rtoc} nhere r is the ratc of dcprcciation.
It.-lbs--!sl!_q sbl -
gr-g-l-e

X=I-rX (3) fro! thc optiEality conditions (Siebert lg8?, p. 621) it follorr
thEt capitrl rill be accunulated if
.-%-,-
the nct rrrg:ina
_

Thc balance-of-paylont r'ertraint, i . c. thc budgct rartrriDt ' it productivity of ir<.*-**w greltcr
capital than thc intcrctt rrt,
given by (Fr (Ko) - r ) r). Capital accuoulation ir financcd by dcbt. tlitl
!h. optinal capitg]_*99!,-!t' -,!_"_ittg deterrined, n._t__ outlut
Q= F(K') - nf,r is:ory!1{_1"". !il_.. Bquation 4 can bc rerrittcn
B=C+I Q+rB (4)
al

wherc B ir the rtock of dcbt and r ir thc interect rct€ divcn in

Q=C+rg-i=C+Z (4a)
the rorld capital rarket.
shcrc Z ie thc trede account.
An irportant propcrty of the rodel are thc tranrvery!-liiJ-Se$i-
t ione. llcre the dirtinctioo botrv.6D finitc and Inflnito tirc It
cruciel.
 behavior of dcbt o.ver. tile lepentlg crucinl ly
.The
to," ^. rhc dirrur"n""
ntereat rate. Irf
I

I
Fx (l(o) - I ) r + !K
+--
(7 a)
I I

) r' (7b)
I I
I
I
I I
:'e courtt!)L-!!Ll I borrow for capital .,{
accunulation aa Hell as for I I

consurJ)tion. Since there are no .. I BIt] I

_
country wtll accrrn I I

, r_ll_to cold a- I
-1
irion Sa. fnvestlent in the initial period is v ,')d I

grven by [' - Xo. In Figures
stock K'i tlK. is the initially
I I
I and 2 OX ig the optinal capital I I
given stock l(o and OH is debt incur_ v I I
.J

rcd, for capital accunulation. In terninal tine T, the optinal

Ti i" h.nd '
"uOit"l "ro.k r to futuro generationa. -

According to condition ?b, the coun!r1 haa a bigh

tirc preference
.9., so rhat ,t g1"o
8.9!! f". .on-ilfi?ioilJlilll ;he rhadow
price of conruaption risor in --..-i<r

"t""!l11 terra over tire, conaunp_

ti"' therefore the countrv nill "*.'.;;;;;".oorillu.

bo..o"ffionly
in the firgt period -
r"l
-.-

{1987' p' 6231, dcbt ril.l increare for sole tinc, and event u.rLy ,)
reaches a laxirun (Fi(ure la)
TR \^,€"1' L*{r!. 0r
(: uR \ l

.J I .e = TJ -;0ol c/r - UT .-as= r1

zlzc. r.!t
f
I ,l .'?R ^f..
tl
I
l
,o^-'- Tr ,l
0"4,ic'u'R'/ Ir,
i t6 - ''ltu' "t 'u-=''
Ftrs ' vt '-)'
Ftgure
t-,^ .,j 46, (, f-f rbJq
1
 I
In Figure 2, the full debt cycle is illustrated, The country
bolrora oH (in Frgure 2a) for c@riuiilTJtn
B d_e.bl___C_9_ryf!€ EF. Consunption rises over tine as shown by thc
curve DIttH'M". In the initial period, consuuption OD is IoHer than
net national product OF (Figure 2b). Debt is repaid by the 6nount
+-
DE, Over tiue, debt and debt service are reduced.

sin-$|gllation being financed by exte4qal borrovina

occurs instantaneously, the very first period is characterized by
u and a deficit in the balance of trsde. Thia
""p:!];ig.t
situation is not depicted in Figure 2. In a nore realistic version
of our nodel, capital accuuulation cannot- occur inetantaneourly
bUt rill be stretched over a nunber of pcriode. Then the countr'y
wil] borrow for a nuuber of periods, and the balance of trade eill
bc ncgative in thig tiue. T.he initial periodg of --
thc full dcbt
cycle can be nodelled rnore realistically if technical progress ia
explicitly introduced and the narginal productivity of capital
rige: for sone tirne, Then the optinal capital stock rires ovef
o tilo, and borrowing nay actually increase,
c
NB
In period J, d.j_!g..o',and the counliv turns into a creditor
plii tion, Dcbt eervicc is zero, and nqt__llr,!put LN_equals conEu!p-
{J
F

tion- LI*l plus capital

%-
exports MH, The country accurulatcr forcian
E !ssets gcnerating a pogitivc scrvicc account.

In Period i', ri@and interegt incore (N'M')

reach a laxinun. The accunulation of foreign a!Eet! !tops: capital
exports turn into capital ilports. Consurption L'M' ir uadc borri-
-- by thc net national product L'N'and interest incorc ll'H'.
blc
I
hf t"a t-', financial rsscts a nd intcrest incore bec otrc Eraller, and
c country har to live fr or depletin I its a!ret r (ll"Q), thrt ir
l,n
It,
o! ilporting capital. Th e trade dc ficit ll"M' ' cannot be fully
1tt nanccd by intcrest inconc (t{"Q).
I

b
-
Flgure 2
 10
gxtending teroinal tiue f into the future, i, o. shifting T to the
ri ght i n Fi dure 2o, 6ives the country nore t ine to postpone con-
sunptionl it therofore can contributc a little lore in the first
period to finance its capital. stock. coneequently, the debt curve
in Figure 2a xi I I ghi ft downsard al loring 'the country to becoue a
crerl itor a little earlier.al
If T approaches infinity and if the tranrversality condition g
appLies, the stock of debt tends to ninus infinity, and the coun-
try is a long-run creditor. Consurption will approach infinity,
tlith production renaining constant, consurption is lainly financed
froo i.nterest incone.s)
Iv.. H i s t o r i ca l..E x anp I eC _9 f,- F9 1.f,. -a4d n.u_! !,_
Sone countries succced in goin6 through thc full dcbt cycle and in
changing their debtor position into a creditor .tatu!. An exanple
is the U.S. who wac a debtor during thc lgth contury and turned
into an internatiooal creditor after lgl4. Bconoric developrent in
the U.S., nalnly driven by thc ncy frontier of the railroad bool
between 1840 - l8?0 (ilandel l9?8, p. 3?9) attracted forcign capi-
tal. Eventually. tha U.S. rac ablc to ropay it. dcbt fror itc pro-
ducLion and to becoue a nct creditor during thc pcriod I9l4
I985.t I Thc balance of tradc war favcrablc bcticen lB?3 to Igl4,
financing dividende and interert gayrcnt abroad (and kccping the
current account in brlance). Xorca ray be an exalple to bc clted
by future gcnerationr.
,1t a.given louent of tinc, the nirror inage of a young debtor
putting foreign funds into productive usc it thc lature credltor.
Prior to 1914, this role was played by tonc Buropean countrier,
especially Great Britain who recclvcd l0 per cent of national
incone frora foreign intcrest and dividcnd incone in 1914.?)
1t
0ther exaaplea of a ful I debt cycle rnay be found in re!ourcc-
exporting countries that successfully use export earnin6s to rep!y
debt and eventually becone creditors. It is the uetamorphoais of
Mexicans into Saudis (Siebert 1985, Chap, VII).
The stinulur to thc start of the fult debt cycle - an increasc in
the nsrg:inaI productivity of capital - nust be interpreted in a
rather broad sense as "a parametric shift or exogenous shock that
draws attention to a neH opportunity for profi t" (Krndleberger
1981, p. 373).
The full debt cycle is reniniscent of the concept of boon Iendin6r
proposed by Xindleberger ( 1981, p, 373). Historical exarnples of
ge! ! I ea
"boon lending" are the withdrawal of the Portuguese royal faniiiy
-c l,_S
to Brazil ( 1808), the boon in South Anerica after in<leperrrtence
fror Spain (1824-25), and the boom in Turkey after the Crinean ltar
and in Bgypt due to cotton denand in the US Civil i{ar, both in thc
1860's, and a peak in lrgentina securities in 1865 rtarted off by
reclanation of Iand fron the native inhabitants (Kindleberg:er
l98l, p. 3?3).
Itlhercac in the full debt cyclc, the debtor beconcs s crerlitor,
"boon lendinge" nay repre!€nt a bubble that eventually blows u9,
Poland in thc 19?0'r is an exanplc where the lar(inal productivity
of cepital asaurcd in the forcign borrouing calculur did not
uaterializc, fn role developing countricc, foreign funds nerc urcd
to finance budget deficitc, not beint uscd for invc!tnents
(llexico after 1978), Undcr there conditions, a booE loan taker the
Propcrty of a con!uuption loan, and thc potential full cycle turns
into a half cycle. Recent exanplcr of the eightie! are thc
woracninS tcral-of-trade, ctgecially for rcrourcc(oil)-exporting
countrier !nd tha riae in the re.al intercgt ratc. Hi!torically,
boor loanr havc turned into consurption loanr in thc Unitcd St6te.
in the 1830'r and in Argentina in the 1880'g (Kindleberlcr 1981,
p. 3?5).
 btDltollt(:K
des lnstituts frlr V/elrwidscho

t2 l3
other countries, honever, s.en to be Iocked into V..-_..1-av-o-q_abIe end Unfavorable Conditions for the Full Debt CycIe
s rrolf debt
cyclc; they continue to be a debtor, at least for a iong tioe. The
r:r'uciar distinction betreen a fur l and a half debt cycle 0ur analys is sugges tg sone condi t ions that ray nake
hinges on it nore likely
O I .. Wi th s lox t ine preference rate relative
to the world or Eore unlikely that a country goes through a full.
debt cycle.
interest rate, the country puts foreign funds into productive
use
r,r;d tenrln to evontunl ly br:conc a crodi t'r. A high tino prefer.enco Apporently, it is nondatory that debt incurred for invcstncnt
is
rrlative to the world interest rate, however, uged for investnent purposea and that the expected
- or a higlr in- narginnl pro_
paticnce - nakes the country a debtor, Foreign ductivity of capital is realized. Then a constant strean of output
funds are used for
conaumption. (exports) is provided to servjce the debt,
Of course, 6n increase
in the productivity of capital in later periode herps to gencrate
In the half debt cycle, future generations nuat repay a positive trade balance. Moreover, in a growing econony,
debt that the
financed consunption of earl ier generstions. It is inflow of equity capitaL alleviates the rigidity of a debt nodel.
rather likely
that, debt is repudiated and default occurs.s)
In the nodel, the tine preference rate of society has becn
consi_
Historical exanples for the half debt cycle or of concuuption dered as givcn, In reality, the ti;1e preference rate of indivi_
lorns are the l2 nillion-debt obtained by the viceroy of ggypt in dualr 1r giv"n, bu! thc inpatience of a gociety is also influenced
1868 (bankruptcy of the Egypt ian governr€nt in lg?6) aod by the political process. rf the tine preference rste bccooes
of thc
0ttoFan 6npire between Igbg and lg?5 (Xindleberger l9gl, p.3?4). Iorrer ovcr tirc, the fulr debt cvcle will be oore likely. Then
eavinga nould increase. However, we do not have a
convincrng
The tine profiles of debt, consuoption and of the balgncc of pay_ theory on changes in the tirne preference rates of individuals.ro)
ment derived froro the intertenporal optinization lodel are A nore relevant aspect ig that institutional
rather arrsngenents to
del icate in the sense that the decicions 6r€ taken sStregate the tine preferences of individuars nay vary over
in an initial tine,
period, and in later periods tbe decisions are effectuated. and that a country as a whole represented by the political
In tbe procers
haif debt cycle, future generations nay not be willint to rtick to nay becole !ore patient or irapatient.
thc pledger of earlier generations. ?he queetion ir, which
iorti-
tutional arrangenents reveal the user costs of foreign debt to It ir an open qucstion whether the policy naker can nake
a. full
individuals and by rhich institutional arrangenentr decentrariged debt cvcle rore rikely by keeping the cffectivc tiuc preference
decisiong of individusls are nade congigtcnt with thc tino pro- rtta of a country low. For instancc, onG could attcrpt to reducc
fi les generated by the lodel. c, thc cffectivc tiae prcference rate by incone or expeoditurc
tax"!.
A condition for such an approach, however, ic that tax
revlnucs
er. trrnrfcrcd into productive capital. 0r one ray rtiaulatc
invc!trrnt at horc by preferential tax tr.atEent. A precondition
hcrc it to prevent capi!al flight due to tsxation !r) and due to
unltlrblc lonetsry conditionr.
 l4
Footnotes
A patenliai deblor country na1. be induced to becooe a creditor, if
for a given tine preference rate of a debtor country the intr:regt t I appreci.ate connents frorn Ngo Van Long, Jesko Hentschel, Murray
rate in the world econony rises. This nay be due to a higher pro_ C. Kenp, Ernst Mohr, Peter l{unnenkanp and Michael Rauscher.
ductivity in other countries, for inctance new frontiers, or it I) On steady state discugsions of capital oovenents for an open
inay be due to a higher preference rate in the ror1d. Hisr:ori-
econotly which contain inplicit or explicit infornation on the debt
cal ly' such a case nay have happened, for instance when a corrntry
profile compare Wan (19?l), Onitsuka (1974) and Lee (1982).
ob'ained neH access to the international capital narket or to the
selnented capitai oarket of a specific countpy.lar
?, If X' ) K, see Long and Srebert (1988).

ior empirical research, it ig tenpting to analyze the tiue pro-

: ) Note that the right-hand side of equation 6 i! equal t" ;.
Ii]es of foreign debt of countries over longer tine gpans and to
Also note t hat fron equation 4a, that conBuEpt ion wi I I agproach
look for epigodes in which either the half dsbt cycle or the full
zero for T"o.
debt cycle were the doninatin{ forccs. I 3 )

') If we release the assunption K = Xr snd alloy the country to

repay part of its debt in tcrninal tine by selling its capital
stock, then T has an irnpact on the level of debt incurred for con-
sunption even if 6 < r, The country may borrov for consunption
initially becauee it can repay debt by selling part of its capital
stock.

s) For utility out of consumption to converEe with r ) 6, it is

nccessary to Itave a specific property of thc utility function
w (c) E C r-t / L - tl where r1 is a constant. lle uust hgve
(r-6)/r1 < r.

3) On data for the net foreign position of the U.S. bctrecn 191,1 -
1966 conpare table 24,4 in t(indlcberger ( 1958).

7, On a"t. for net foreign posit ions Frior to l9I4 tee l{ande I
(19?8, p. 379), lloodruff (19?3. p.707),
?
tb l7
i

o ) The hslf
cvcie of debt nray actually turn into a cycle of debt I 2,
A case in point nay be the capi tal narket of forner colonies
and defoul t. Historical exauples are Latin Arerica, the lliddle being seguented irr favor of the mother country and eventuall)
Iiast and Czarist Russia. Xindlebergcr (1981, p. 3?5) lentions Gua- being opened to other countries as nelI.
i.le,nala "with borrowing in 1825, default in lg2g. settlereut in
1S56, neH very snall loans in 1863, these defaulted in 1864, new I3) Enpirical data for the oajor indebted developing countries
lo,ns in 1869, al I Ioans defaulted in lB?6, settlerent in lgg4, shoH a tiue profile with progressively rising debt, (for instance
n€! Loans in 1888' defaulted in lg94r D€r{ arrangeeent in Igg5, l{oreg I965 - 1985; Argentina l9?0 - 1982) or a tipe profile where
thrl not carried out, ne$ agreeuent in l90l-02, new agreeuent in the rate of increase of debt is reduced (Argentina for the period
jlg03, new agreeuent in 1904, nerr loan in lg0g, agreenent of lgg5 1982 - 1986 relative to 1978 - 1982). On date see tiorld Bank
t'esuned in i912, railnay loan in 1924, new loans in lg2z and lg2g, ( I988). It would be interesting to find historical cases rhere
oofaulted in 1931". debt sctually was reduced (for instance Argentina reduced its
foroign debt fron 390 uillion gold dollars to 290 rillion !old
4t Tlre stnall
country caae with a given interegt rate in t!re world dollars in the beginning of thia century, Tang 192I, p. l3l).
cnpi tol narket should be extended to congider a world containing
Lflo. lurgc countries where the intcre!t rate ie deteruined
endogeneous ly. The advantage of such a nodel is to explicitly
introduce the capital rerhet and to illustrate the creditor and
debtor position of different countriea at a given lorent of tile,
that is llalrat'lar of dcbt. I owe thia idea to Murray C. Kenp,

ro) If prosperous pcriodr givc rise to a highcr rats of tine pre-

ference as put forward by Neunsnn (rg8s), tbe full debt cycle
becomes lesa likelyr and tbc creditor or potcntial creditor rill
tend to becone a debtor.

rr )seguenting the ngtional capital rarkct fror thc international

narket, if it can be cffectively donc at rll, ray bring about a il
higher interest ratc at hore rnd conrcquently hithcr r.vingr. But
at the sane tinc, thc country haa hifher opportunity coete in r/

lerns of foregone conrulption by not borroring. llorcover, if

segnentation inducee capital flight, lacr fundr aro avairable at
hore. Another approach ray be to rcltrain thc cccecr to the world
copital narket for consurgtion debt. \
 l8 l9
llefcrcnc<ls Tang, liilheln (iS:ll), Bank-,6eld- und Finanzwesen, in: Josef
\Bo.t", Hellauer (Hrsg.;, Argentinien - Wirtschaft und Wirtschaf!s-
Georgc ll. (1964), A Theory of Long - Run Internationnl
grundlagen, Le\pzi g und Berlin, ll3-133.
Capital Moveroenls, Journal of Poiitical Econouy, VoI. 72,
34t"354
Van Long, Ngo, Horst Siebert ( 1988), Optinal Foreign Borrowing:
Sensitivity Analysis with Respect to the Planning Horizon.
{),ar}bcrg, M. (I985), 6xternal versus Internsl public Debt - A
Kiel l{orkinf Paper.
Thcoretical Analysis of tho Long-Run Burden, Zeitechrift. fiir
llut.ionnlrjkonomie, 45, l4l-i54.
Wan, Henry Y. (f97I), A SiDultaneous - Variational llodel for
International Capi.taI Movenent, in: J. Bhagwoti (ed. ), frade,
Kindleberger, Charles P, ( l96B), International Econonics, Hornewood
Balance of Paynents and Growth, Ansterdan, 261-287.
(I11)., 4th ed.

Wandel, Eckhard (I9?8), Artikel "Kapitalbewegungen, internationsle

indlr:berger, Charles P. (1981 ), Debt Situation of the Developing
I. Geschichte", Handw6rterbuch der l{irtschaftswissenschaften,
Countries in Historical Perapect ive ( lB00-1945), Aurcenrrirt-
Bd, 4, TUbingen, 379-388.
schaft, 3?2-380.
l{oodruff, llilliarn (f9?3), The Etrergence of an International Eco-
Lee, C. Jevour (1982), Capital MoveDenta, Growth snd the Balance
nory l?00-1914, p. 656-?38, in: CipoIla, C.M,, Thc Fontana
of Payments, Journal of Macroecono.ics, 4, 433-44?.
Econoni.c History of Europe, Part Two, London and GlasgoH,
p, 707,
Heher', Ph. A. (1971), Econouic Growth rnd Developnent. A !{athena-
t ical InLroduction, Ner York.
llorld Bank (1985), l{orld Developrent Report, liashington D.C.

Neumann, Man fred ( 1 985 ) , Long Swings in Econonic Dcveloplent,

l{orId Bank (1988), l{orld Debt TabIes, Itashington.
Zeitgchrift fijr die gesaate itaatEriesenschaft, l4I, 2l-35.

\onitsuka, y. (19?4), International Capital Moverentr and the

Pattern
24-36.
of Bconolic Growth, Arcrican Econolic Rovicr, 64,
Vdh \8q
Siebert,
try.
Horat ( I985), Econolicr-of the Reaourcc-BxportiDg coun-
Intertenporal Theory of Supply and Trada, Greennich,
x\ lAeot
Siebert, Horst (1987), Foreign Debt and Capital Accurulation,
i ru i I

l{el twirtschaf t I ichcc rlrchiv , 123/4, 518-630.