December 3rd, 2014
from the Richmond Fed
While economists have made substantial progress exploring this question, the answer remains unclear. The answer is important because financial regulation that does not address a specific market failure risks causing new inefficiencies and unintended consequences in the financial system and broader economy. To demonstrate how economic theory can be used to identify market failures and guide policy, this Economic Brief discusses a common market failure called a "pecuniary externality" and demonstrates the pitfalls of applying regulations in situations where the precise sources of market failures are not well-understood.