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The euro as a reserve currency: a challenge to the pre-eminence of the US dollar?

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Author Info
Gabriele Galati (De Nederlandsche Bank, The Netherlands)
Philip Wooldridge (Bank for International Settlements, Hong Kong)

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Abstract

Well-developed financial markets are a necessary condition for a currency to play a role as a reserve currency. The introduction of the euro greatly improved the functioning of euro financial markets. This paper investigates whether euro financial markets have developed sufficiently to facilitate the emergence of the euro as a reserve currency on par with the US dollar. We find that the liquidity and breadth of euro financial markets are fast approaching those of dollar markets, and as a result the euro is eroding some of the advantages that have historically supported the pre-eminence of the US dollar as a reserve currency. This strengthens the incentive for monetary authorities to reconsider the currency composition of their reserves. Nevertheless, the introduction of the euro has not yet resulted in a significant change in the currency composition of official reserve holdings. The US dollar has maintained its place as the dominant reserve currency, supported perhaps by the edge that dollar financial markets still have over euro markets in terms of size, credit quality, and liquidity, as well as inertia in the use of international currencies. Copyright © 2008 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.379
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Publisher Info
Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 14 (2009)
Issue (Month): 1 ()
Pages: 1-23
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Handle: RePEc:ijf:ijfiec:v:14:y:2009:i:1:p:1-23

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Elias Papaioannou & Richard Portes & Gregorios Siourounis, 2006. "Optimal Currency Shares in International Reserves: The Impact of the Euro and the Prospects for the Dollar," NBER Working Papers 12333, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Richard Portes & Hélène Rey, 1998. "The emergence of the euro as an international currency," Economic Policy, CEPR, CES, MSH, vol. 13(26), pages 305-343, 04. [Downloadable!] (restricted)
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  3. Krugman, Paul, 1980. "Vehicle Currencies and the Structure of International Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 513-26, August. [Downloadable!] (restricted)
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  4. Eichengreen, Barry, 1998. "The Euro as a Reserve Currency," Journal of the Japanese and International Economies, Elsevier, vol. 12(4), pages 483-506, December. [Downloadable!] (restricted)
  5. Hartmann, Philipp & Issing, Otmar, 2002. "The international role of the euro," Journal of Policy Modeling, Elsevier, vol. 24(4), pages 315-345, July. [Downloadable!] (restricted)
  6. Pagano, Marco & von Thadden, Ernst-Ludwig, 2004. "The European Bond Markets Under EMU," CEPR Discussion Papers 4779, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Donald J. Mathieson & Barry J. Eichengreen, 2000. "The Currency Composition of Foreign Exchange Reserves - Retrospect and Prospect," IMF Working Papers 00/131, International Monetary Fund.
  8. Rey, Helene, 2001. "International Trade and Currency Exchange," Review of Economic Studies, Blackwell Publishing, vol. 68(2), pages 443-64, April.
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  9. Garcia-Herrero, Alicia & Terada-Hagiwara, Akiko, 2007. "Do Asian investors rebalance their portfolios and what are the consequences?," Journal of Asian Economics, Elsevier, vol. 18(1), pages 195-216, February. [Downloadable!] (restricted)
  10. Xavier Freixas, 2004. "The Assessment: European Financial Integration," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 475-489, Winter.
  11. Paul R. Krugman, 1984. "The International Role of the Dollar: Theory and Prospect," NBER Chapters, in: Exchange Rate Theory and Practice, pages 261-278 National Bureau of Economic Research, Inc. [Downloadable!]
  12. Claessens, Stijn, 1992. "The Optimal Currency Composition of External Debt: Theory and Applications to Mexico and Brazil," World Bank Economic Review, Oxford University Press, vol. 6(3), pages 503-28, September.
  13. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August. [Downloadable!] (restricted)
  14. McCauley, R.N., 1997. "The Euro and the Dollar," Princeton Essays in International Economics 205, International Economics Section, Departement of Economics Princeton University,.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Chinn, Menzie & Frankel, Jeffrey, 2008. "The Euro May over the Next 15 Years Surpass the Dollar as Leading International Currency," Working Paper Series rwp08-016, Harvard University, John F. Kennedy School of Government. [Downloadable!]
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  2. Yosuke Tsuyuguchi & Philip D Wooldridge, 2008. "The evolution of trading activity in Asian foreign exchange markets," BIS Working Papers 252, Bank for International Settlements. [Downloadable!]
  3. Gunther Schnabl, 2006. "The Evolution of the East Asian Currency Baskets – Still Undisclosed and Changing," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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