Pecuniary Externalities in Economies with Financial Frictions

Abstract

This paper combines the manuscripts "Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses" by Anton Korinek (2011) and "Dissecting Fire Sales Externalities" by Eduardo Dávila (2014). An earlier version of the combined manuscript was circulated under the title "Fire-Sale Externalities." We thank our editor, Dimitri Vayanos, and three anonymous referees for their guidance and insightful comments. We are also greatly indebted to participants at numerous conference and seminar presentations who have provided many helpful comments. Korinek is grateful for financial support from the Lamfalussy Fellowship of the ECB, the Institute for New Economic Thinking, and the NFI. Dávila is grateful for financial support from the Rafael del Pino Foundation. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Where modern macroeconomics went wrong

“…So too, additional financial instruments can lead to greater economic instability (Brock et al 2008, Caccioli et al 2009, partly because these financial instruments create new betting opportunities, which enhance volatility (Guzman and Stiglitz 2016a, b). 33 See Korinek (2010Korinek ( , 2011aKorinek ( ,b, 2012, Jeanne and Korinek (2010), and Davila and Korinek (2017). Shleifer and Vishny (2011) provide a partial review of firesale models.…”

Bond Finance, Bank Finance, and Bank Regulation

“…The framework proposed in this paper is rather simple as it is meant to highlight a feature that is currently missing in the literature, that is, the effectiveness of banking regulation highly depends on the elasticity of demand for bank loans, which in turn relies on the presence of the bond market. 2 In my model, banking regulation mitigates pecuniary externalities and improves social welfare via the distributive effects emphasized by Dávila and Korinek (2017).…”

Systemic risk and bank business models

“…5 Hence the regulator may even be concerned with banks suffering passively from systemic shocks, because such banks impose a larger expected cost on the real economy in a potential crisis (see, e.g., Acharya & Yorulmazer, 2007;Acharya et al, 2017;Dàvila & Korinek, 2018;Wagner, 2010). As mentioned before, this measure does not reveal the underlying cause of the comovement.…”