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Pecuniary Externality through Credit Constraints: Two Examples without Uncertainty

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    Rights statement: © Hardman-Moore, J. (2013). Pecuniary Externality through Credit Constraints: Two Examples without Uncertainty. (pp. 1-18). Edinburgh School of Economics Discussion Paper Series.

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Original languageEnglish
PublisherEdinburgh School of Economics Discussion Paper Series
Number of pages19
StatePublished - Oct 2013

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NameESE Discussion Papers


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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