Working Paper: NBER ID: w14088
Authors: Pierrichard Agenor; Joshua Aizenman
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: No keywords provided
JEL Codes: F12; F15; F2; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital market imperfections (G19) | welfare from forming a currency union (F36) |
| cost of financial intermediation falls (G20) | welfare improves (I30) |
| increased bank competition (G21) | reduction in cost of credit (G21) |
| reduction in cost of credit (G21) | increase in investment (E22) |
| increase in investment (E22) | enhancement of welfare (I30) |
| elimination of transaction costs (D23) | welfare gains (D69) |
| diversification of asset portfolios (G11) | reduction of risk premiums (G19) |
| reduction of risk premiums (G19) | welfare improvements (I38) |