Capital Market Imperfections and the Theory of Optimum Currency Areas

Pierre-Richard Agénor () and Joshua Aizenman ()

No 14088, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper studies how capital market imperfections affect the welfare effects of forming a currency union. The analysis considers a bank-only world where intermediaries compete in Cournot fashion and monitoring and state verification are costly. The first part determines the credit market equilibrium and the optimal number of banks, prior to joining the union. The second part discusses the benefits from joining a currency union. A competition effect is identified and related to the added monitoring costs that banks may incur when operating outside their home country, through an argument akin to the Brander-Krugman "reciprocal dumping" model of bilateral trade. Whether joining a union raises welfare of the home country is shown to depend on the relative strength of "investment creation" and "intermediation diversion" effects.

JEL-codes: F12 F15 F2 F36 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-opm
Date: Written 2008-06
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