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Understanding Market Failure in the 2007-08 Crisis

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  • Borys Grochulski
  • Wendy Morrison

Abstract

Did market failures cause the 2007-08 financial crisis? While economists have made substantial progress exploring this question, the answer remains unclear. The answer is important because financial regulation that does not address a specific market failure risks causing new inefficiencies and unintended consequences in the financial system and broader economy. To demonstrate how economic theory can be used to identify market failures and guide policy, this Economic Brief discusses a common market failure called a "pecuniary externality" and demonstrates the pitfalls of applying regulations in situations where the precise sources of market failures are not well-understood.

Suggested Citation

  • Borys Grochulski & Wendy Morrison, 2014. "Understanding Market Failure in the 2007-08 Crisis," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue Dec.
    • Handle: RePEc:fip:fedreb:00022
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