Capital Market Imperfections and the Theory of Optimum Currency Areas

37 Pages Posted: 1 Sep 2008

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 3, 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.

Keywords: Optimum theory, Captial markets, Currency areas

JEL Classification: E43, F36, G28

Suggested Citation

Agenor, Pierre-Richard and Aizenman, Joshua, Capital Market Imperfections and the Theory of Optimum Currency Areas (June 3, 2008). Available at SSRN: https://ssrn.com/abstract=1260367 or http://dx.doi.org/10.2139/ssrn.1260367

Pierre-Richard Agenor

University of Manchester - School of Social Sciences ( email )

Oxford Road
Manchester, M13 9PL
United Kingdom

Joshua Aizenman (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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