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Why the Euro Will Rival the Dollar

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Author Info

  • Menzie Chinn
  • Jeffrey Frankel

Abstract

The euro has arisen as a credible eventual competitor to the dollar as leading international currency, much as the dollar rose to challenge the pound 70 years ago. This paper uses econometrically-estimated determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, rate of return, and liquidity in the relevant home financial center (as measured by the turnover in its foreign exchange market). There is a tipping phenomenon, but changes are felt only with a long lag (we estimate a weight on the preceding year’s currency share around .9). The equation correctly predicts out-of-sample a (small) narrowing in the gap between the dollar and euro over the period 1999-2007. This paper updates calculations regarding possible scenarios for the future. We exclude the scenario where the United Kingdom joins euroland. But we do take into account of the fact that London has nonetheless become the de facto financial center of the euro, more so than Frankfurt. We also assume that the dollar continues in the future to depreciate at the trend rate that it has shown on average over the last 20 years. The conclusion is that the euro may surpass the dollar as leading international reserve currency as early as 2015.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 11 (2008)
Issue (Month): 1 (05)
Pages: 49-73

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Handle: RePEc:bla:intfin:v:11:y:2008:i:1:p:49-73

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Cited by:
  1. Benjamin Cohen, 2012. "The Benefits and Costs of an International Currency: Getting the Calculus Right," Open Economies Review, Springer, vol. 23(1), pages 13-31, February.
  2. Jérémie Cohen-Setton & Jean Pisani-Ferry, 2008. "Asia-Europe: The Third Link," Working Papers 44, Bruegel.
  3. Robert N McCauley & Catherine R Schenk, 2014. "Reforming the international monetary system in the 1970s and 2000s: would an SDR substitution account have worked?," BIS Working Papers 444, Bank for International Settlements.
  4. Satyendra Kumar Gupta & Ashima Goyal, 2014. "Reserve currencies: Can multiplicity work?," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2014-010, Indira Gandhi Institute of Development Research, Mumbai, India.
  5. Ryan, John, 2009. "China and the Reserve Currency Question," MPRA Paper 18218, University Library of Munich, Germany.
  6. Christian Thimann, 2008. "Global Roles of Currencies," International Finance, Wiley Blackwell, vol. 11(3), pages 211-245, December.
  7. A. Malliaris & Mary Malliaris, 2013. "Are oil, gold and the euro inter-related? Time series and neural network analysis," Review of Quantitative Finance and Accounting, Springer, vol. 40(1), pages 1-14, January.
  8. Agnes Benassy-Quere & Jean Pisani-Ferry, 2011. "What International Monetary System for a Fast-Changing World Economy?," Book Chapters, in: Jack T. Boorman & André Icard (ed.), Reform of the International Monetary System: The Palais Royal Initiative, chapter 21, pages 255-298 Emerging Markets Forum.
  9. Maximo Camacho & Marcos Dal Bianco & Gabriel Perez Quiros, 2012. "Short-run forecasting of the euro-dollar exchange rate with economic fundamentals," Working Papers 1201, BBVA Bank, Economic Research Department.
  10. Aizenman, Joshua & Marion, Nancy, 2009. "Using Inflation to Erode the U.S. Public Debt," Santa Cruz Department of Economics, Working Paper Series qt6xf174rs, Department of Economics, UC Santa Cruz.
  11. Fischer, Christoph, 2012. "Currency blocs in the 21st century," BOFIT Discussion Papers 24/2012, Bank of Finland, Institute for Economies in Transition.
  12. Huang, Yiping & Wang, Daili & Fan, Gang, 2014. "Paths to a Reserve Currency: Internationalization of the Renminbi and Its Implications," ADBI Working Papers 482, Asian Development Bank Institute.
  13. John Ryan, 2009. "China and the Global Roles of Currencies," Working Papers 2009.8, International Network for Economic Research - INFER.
  14. Stiglitz Joseph E & Greenwald Bruce, 2010. "Towards A New Global Reserve System," Journal of Globalization and Development, De Gruyter, vol. 1(2), pages 1-26, December.

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