Capital Market Imperfections and the Theory of Optimum Currency Areas

38 Pages Posted: 22 Jun 2008 Last revised: 1 Jul 2010

See all articles by Pierre-Richard Agenor

Pierre-Richard Agenor

University of Manchester - School of Social Sciences

Joshua Aizenman

National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2008

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.

Suggested Citation

Agenor, Pierre-Richard and Aizenman, Joshua, Capital Market Imperfections and the Theory of Optimum Currency Areas (June 2008). NBER Working Paper No. w14088. Available at SSRN: https://ssrn.com/abstract=1149334

Pierre-Richard Agenor (Contact Author)

University of Manchester - School of Social Sciences ( email )

Oxford Road
Manchester, M13 9PL
United Kingdom

Joshua Aizenman

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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