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Pecuniary Externality through Credit Constraints: Two Examples without Uncertainty

  • Moore, John

This paper is a contribution to the growing literature on constrained inefficiencies in economies with financial frictions. The purpose is to present two simple examples, inspired by the stochastic models in Gersbach-Rochet (2012) and Lorenzoni (2008), of deterministic environments in which such inefficiencies arise through credit constraints. Common to both examples is a pecuniary externality, which operates through an asset price. In the second example, a simple transfer between two groups of agents can bring about a Pareto improvement. In a first best economy, there are no pecuniary externalities because marginal productivities are equalised. But when agents face credit constraints, there is a wedge between their marginal productivities and those of the non-credit-constrained agents. The wedge is the source of the pecuniary externality: economies with these kinds of imperfections in credit markets are not second-best efficient. This is akin to the constrained inefficiency of an economy with incomplete markets, as in Geanakoplos and Polemarchakis (1986).

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Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2013-71.

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Date of creation: 2013
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Handle: RePEc:edn:sirdps:494
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  1. Javier Bianchi, 2010. "Overborrowing and Systemic Externalities in the Business Cycle," 2010 Meeting Papers 96, Society for Economic Dynamics.
  2. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  3. Hans Gersbach & Jeanā€Charles Rochet, 2012. "Aggregate Investment Externalities and Macroprudential Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44, pages 73-109, December.
  4. Anton Korinek, 2011. "The New Economics of Prudential Capital Controls: A Research Agenda," IMF Economic Review, Palgrave Macmillan, vol. 59(3), pages 523-561, August.
  5. Jeanne, Olivier & Korinek, Anton, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," CEPR Discussion Papers 8015, C.E.P.R. Discussion Papers.
  6. Anton Korinek & Olivier Jeanne, 2013. "Macroprudential Regulation Versus Mopping Up After the Crash," 2013 Meeting Papers 405, Society for Economic Dynamics.
  7. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
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