In the first decade of its existence, the European Monetary System passed through three phases of realignments: full accommodation, partial accommodation, and zero accommodation of inflation differentials. But to what extent does the new freedom of capital movements rule out such gradual...

The authors consider an overlapping generations economy where capital is produced from bank loans under stochastic constant returns to scale and subject to idiosyncratic shocks whose realizations are costly to verify. Their formulation differs from earlier work in permitting investment projects...