Public Policy Toward Pecuniary Externalities

Abstract

Pecuniary externalities create third-party effects through changes in relative prices or asset prices. Unlike technological externalities, they do not misallocate resources and are necessary for the market to work efficiently. However, the political process does not differentiate pecuniary from technological externalities and often tries to prevent pecuniary externalities, which creates resource misallocations. The article shows how pecuniary externalities function in markets, why the political process takes account of pecuniary externalities, and why public policy toward pecuniary externalities results in resource misallocations.