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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. Agnes Benassy-Quere & Jean Pisani-Ferry, 2011. "Quel systeme monetaire international pour une economie mondiale en mutation rapide ?," Working Papers 2011-04a, CEPII research center.
  2. Ryan, John, 2009. "China and the Reserve Currency Question," MPRA Paper 18218, University Library of Munich, Germany.
  3. Christoph Fischer, 2011. "Currency blocs in the 21st century," Globalization and Monetary Policy Institute Working Paper 87, Federal Reserve Bank of Dallas.
  4. Jérémie Cohen-Setton & Jean Pisani-Ferry, 2008. "Asia-Europe: The Third Link," Working Papers 44, Bruegel.
  5. John Ryan, 2009. "China and the Global Roles of Currencies," Working Papers 2009.8, International Network for Economic Research - INFER.
  6. Christian Thimann, 2008. "Global Roles of Currencies," International Finance, Wiley Blackwell, vol. 11(3), pages 211-245, December.
  7. Malliaris, A.G. & Malliaris, Mary, 2011. "Are oil, gold and the euro inter-related? time series and neural network analysis," MPRA Paper 35266, University Library of Munich, Germany.
  8. Joshua Aizenman & Nancy Marion, 2009. "Using Inflation to Erode the U.S. Public Debt," NBER Working Papers 15562, National Bureau of Economic Research, Inc.

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