Sovereign debt, aid, and currency crises

Chapters one and two analyze debt and aid issues faced by low-income countries (LICs). Over the last two decades, LICs have suffered from repeated debt crises. To understand these problems, one must understand the characteristics of LIC loans and debt treatments and incorporate them into the modeling approach. Chapter one, "Sovereign Debt in Low-Income Countries: A Comparison with Middle-Income Countries," documents specific features of LIC loans and debt treatments, contrasts these features with those of middle-income countries (MICs), and finally discusses the caveats in applying the existing theories, which are mostly designed for MICs, to an LIC environment.;A distinguishing feature of LICs is that they are significant recipients of aid. In Chapter two, "Grants or Concessional Loans? Aid to Low-Income Countries with a Participation Constraint," I build a dynamic contracting model to answer the question of whether LICs should be given concessional loans or grants. Under concessional lending, the donor lends at a low interest rate if the recipient country lies below or at the cutoff, the level of income above which a country loses its eligibility for aid. In addition the donor imposes a constraint that prevents the country from defaulting. The country maximizes the welfare of all its households subject to this lending rule. Concerning grants, the donor designs the sequence of gifts that maximizes the country's welfare, keeping the same budget across different schemes. I find that concessional lending may motivate a country to remain permanently at the cutoff. Whether or not this poverty trap occurs depends on the country's Total Factor Productivity level and initial conditions. However, in the case of the optimal grant scheme (a one-time gift in period 1) a poverty trap does not result. In reality though, it may be difficult for a donor to commit itself to such a grant scheme.;Chapter three, "The Effectiveness of Higher Interest Rate Policy in Fighting Against Sharp Depreciation" focuses on a small open economy under a flexible exchange rate regime. It provides a simple staggered-price model with a Taylor rule to show that a higher interest rate policy may amplify the magnitude of exchange rate depreciation depending on assumptions placed on exogenous shocks.