This paper presents a two-country overlapping generations model in which financial intermediation arises endogenously as an incentive-compatible means of economizing on monitoring costs. Because of the existence of transactions costs, money markets in the two countries are segmented and investors have differential access to international credit markets. The model is used to generate predictions about the role of international intermediation in economic development and to examine the nature of business cycle phenomena across alternative exchange rate regimes. Disturbances are propagated by a credit allocation mechanism, which also lends a novel flavor to the model’s long-run properties.
Published in: _Journal of Monetary Economics_ (Vol. 23, No. 3, May 1989, pp. 401-431) https://doi.org/10.1016/0304-3932(89)90040-8.