Pecuniary Externalities in Economies with Financial Frictions / Eduardo Dávila, Anton Korinek.

Format:

Book

Author/Creator:

Dávila, Eduardo.

Contributor:

Korinek, Anton.

National Bureau of Economic Research.

Series:

Working paper series (National Bureau of Economic Research) no. 22444.

NBER working paper series no. w22444

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2016.

Summary:

This paper characterizes the efficiency properties of competitive economies with financial constraints, in which phenomena such as fire sales and financial amplification may arise. We show that financial constraints lead to two distinct types of pecuniary externalities: distributive externalities that arise from incomplete insurance markets and collateral externalities that arise from price-dependent financial constraints. For both types of externalities, we identify three sufficient statistics that determine optimal taxes on financing and investment decisions to implement constrained efficient allocations. We also show that fire sales and financial amplification are neither necessary nor sufficient to generate inefficient pecuniary externalities. We demonstrate how to employ our framework in a number of applications. Whereas collateral externalities generally lead to over-borrowing, the distortions from distributive externalities may easily flip sign, leading to either under- or over-borrowing. Both types of externalities may lead to under- or over-investment.

Notes:

July 2016.

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