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Capital Market Imperfections and the Theory of Optimum Currency Areas

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Author Info
Pierre-Richard Agenor
Joshua Aizenman

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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14088.

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Date of creation: Jun 2008
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Handle: RePEc:nbr:nberwo:14088

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Find related papers by JEL classification:
F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies
F15 - International Economics - - Trade - - - Economic Integration
F2 - International Economics - - International Factor Movements and International Business
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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  1. HOLLAND, Márcio & LUIZ CARLOS, BRESSER-PEREIRA, 2009. "Common currency and economic integration in mercosur," Textos para discussão 190, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil). [Downloadable!]
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