Pecuniary Externality through Credit Constraints: Two Examples without Uncertainty

Research output: Working paperDiscussion paper

Abstract / Description of output

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).
Original languageEnglish
PublisherEdinburgh School of Economics Discussion Paper Series
Number of pages19
Publication statusPublished - Oct 2013

Publication series

NameESE Discussion Papers


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