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## Need help with a question - The Debt Crisis

This topic has 1 expert reply and 2 member replies
sidchilling Junior | Next Rank: 30 Posts
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#### Need help with a question - The Debt Crisis

Fri Oct 30, 2015 6:15 am

The debt crisis affecting many developing countries has had three causes: imprudent management and borrowing by debtor countries; imprudent lending by banks; and rising interest rates. The unprecedented rise in real interest rates to about 6 percent by 1982 increased the burden on borrowers and completely changed the nature of the debt problem. In past debt crises, when loans were made at fixed rates, real interest rates rose with deflation. But once price levels stabilized, the interest burden would be higher only to the extent of the proportional decline in price levels, and it remained quite possible that inflation would eventually reduce the burden. In this crisis, though, the real interest rate has risen and stayed high, and inflation has brought no relief.

During the 1980s, fear of financial loss led US commercial banks to curtail sharply their lending activity in debtor countries. In 1982, nine large banks had over 250 percent of their capital in loans to developing countries; by mid-1986, the nine banks had reduced their activities to the point where they had sufficient equity and reserves to withstand potential losses. Although banks have stabilized their positions, many continue to carry developing-country debt at face value.

Present bank strategies deal with the debt crisis by extending the effective maturity of loans. Although any method that reduces the flow of resources from debtor countries will help in the short run, further lending promises little relief to the debt problem. As long as real interest rates remain high, developing countries will remain in debt.

Q. The author suggests that methods currently in place for dealing with the debt crisis are inadequate because they.

A. increase the upward pressure on real interest rates without allowing any opportunity for reduction.

B. allow real wages to rise at the expense of economic growth in debtor countries.

C. fail to address problems of mismanagement in debtor and creditor countries.

D. do not promote long-term growth.

E. sacrifice a reduction of real interest rates for a short-term increase in loan maturity.

Help appreciated.

VivianKerr GMAT Instructor
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17 Dec 2010
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Tue Nov 03, 2015 12:34 am
Hey Sid,

To start, make sure you're using a precise and valuable system of note-taking to help you break down the passage and draw inferences as you read. I extract the Topic, Scope, Function of each paragraph, Point of View of the author, and the Purpose of the entire passage as I read.

Here's how I'd do my notes for this particular passage:

Topic: debt crisis
Scope: its causes
First paragraph: to lay out 3 causes
Second paragraph: to explain what banks did in 80's
Third paragraph: to describe what banks do today
Author's POV: Banks
Purpose: to overview causes of debt crisis

Now that we fully grasp the passage, we can move on to rephrasing the question:

The author suggests that methods currently in place for dealing with the debt crisis are inadequate because they

Why do current methods suck? Why don't they WORK?

Now we have to go back to the passage and find the answer BEFORE looking at the answer choices!

According to our passage map, the author discusses the current situation in the last paragraph. He states the banks extend the "maturity of loans" but it "reduces the flow of resources" and will only help in "the short run."

Prediction: long loans + less resources = short run only

Now let's run through the answer choices, and put a "+", "-", or "?" based on how close the choice matches our prediction.

A. -
B. -
C. -
D. +
E. +

It is obviously between D and E since they are the only ones that discuss growth potential (long term v. short term). E contains the tempting phrase "short-term," but when we look closely, it is contradicted by an earlier detail.

The passage states that the banks are "extending the effective maturity of loans." The word "short-term" in our prediction referred to a temporary solution, NOT to the idea that the loan maturity itself is "short-term." Very tricky!

Takeaways

- don't be wooed by an answer choice just because it repeats something from the passage
- always narrow it down to the "Final Two" and weigh them against each other
- use your passage map to zero in on the location of the relevant information and re-read

_________________
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soudeh Junior | Next Rank: 30 Posts
Joined
20 Apr 2017
Posted:
21 messages
Sun Oct 01, 2017 1:52 pm
Hello

I really confused
choice A says: increase the upward pressure on real interest rates without allowing any opportunity for reduction.

and the last sentence similarly says: As long as real interest rates remain high, developing countries will remain in debt.

why A is wrong?

### GMAT/MBA Expert

ErikaPrepScholar Legendary Member
Joined
20 Jul 2017
Posted:
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GMAT Score:
770
Tue Oct 03, 2017 9:52 am
Hi soudeh,

A key phrase here is "increase the upward pressure on real interest rates". The idea that current bank strategies do not "[allow] any opportunity for reduction" is supported by the last sentence of the passage, but there is no indication that current strategies are increasing real interest rates. We just know that current bank strategies causes real interest rates to remain high - in other words, they could be staying exactly where they are.

Answer choices being half right or almost right is a common trap on the GMAT. It's important to be sure that 100% of the answer choice is supported by the passage before selecting it!

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