Pecuniary Externalities in Competitive Economies with Limited Pledgeability

V. Filipe Martins-Da-Rocha (), Toan Phan () and Yiannis Vailakis ()
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V. Filipe Martins-Da-Rocha: LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique, EESP - Sao Paulo School of Economics - FGV - Fundacao Getulio Vargas [Rio de Janeiro]
Toan Phan: Federal Reserve Bank of Richmond
Yiannis Vailakis: Adam Smith Business School - University of Glasgow

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Abstract: We analyze the efficiency properties of competitive economies with strategic default and limited pledgeability. We show that laissez-faire equilibria can be constrained suboptimal. Under certain conditions, imposing tighter borrowing constraints (relative to the laissez-faire regime) can make everybody in the economy better off. The inefficiency is due to the interaction between debt pricing and the default option, which generates a pecuniary externality. We also show that a Pigouvian subsidy on net financial positions may induce borrowers to internalize this externality and increase welfare.

Keywords: Limited pledgeability; Debt constraints; Constrained inefficiency; Macroprudential interventions. (search for similar items in EconPapers)
Date: 2022-12-21
New Economics Papers: this item is included in nep-dge and nep-fdg
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