Forgive or buy back: an experimental study of debt relief

Abstract

In recent years, debt relief has once again been pushed to the forefront of political and economic interest. The general consensus is that with less debt burden poor countries suffering from debt overhang will be able devote more resources towards investment thereby promoting their own growth and thus benefit their creditors in the long run. An open question is which mechanism is best to relieve debt burden. In this paper, we adopt experimental methods to study the effectiveness and efficiency of debt forgiveness and debt buyback. We find that creditors tend to reduce more debt under Forgiveness than Buyback. Debtors under Forgiveness are not significantly more reciprocal than under Buyback. After controlling for the amount of debt relief, creditors are significantly worse off under Forgiveness whereas debtors are indifferent between the two schemes. From the viewpoint of promoting debt relief, debt forgiveness appears to be a more effective tool to achieve this goal. Nevertheless, if one is to maximize the overall efficiency, debt buyback is superior to debt forgiveness in making best of each relief dollar.