Working Paper Series no. 450: Currency Union with and without Banking Union

Abstract

This paper analyzes a two-country model of currency, banks and endogenous default to study whether impediments to credit market integration across jurisdictions impact the desirability of a currency union. We show that when those impediments induce a higher cost for banks to manage cross-border credit compared to domestic credit, welfare may not be maximal under a regime of currency union. But a banking union that would suppress hurdles to banking integration restores the optimality of that currency arrangement. The empirical and policy implications in terms of banking union are discussed.

Vincent Bignon, Régis Breton and Mariana Rojas Breu
October 2013

Classification JEL : E42, E50, F3, G21

Keywords : banks, currency union, credit, default, limited commitment