A macroeconomic view of Eurodollar market expansion after 1973

This paper analyzes the Eurodollar market, investigating the reasons for its expansion after 1973, and the consequences for monetary policy. In the first part of the paper, the issue of credit and money creation by offshore banks is considered. The nature of the liquidity creation process is shown to be dependent on the specific definitions of money and balance of payments position that are adopted by the national authorities. The concepts of money (in domestic and foreign currencies)held by residents and of basic balance are specified, and it is demonstrated that the domestic economy of a given country is not directly affected by the external use of its currency between non-residents. The development of these external transactions, however, proves to be directly dependent on the domestic policies followed by the monetary authorities of that country. The second part of the paper is devoted to an empirical analysis of the development of the Eurodollar market during the period from 1974 to 1980. Estimates of a partial adjustment model show that credit expansion in the Eurodollar market during this period was largely "demand determined," owing to the monetary policy implemented by the Federal Reserve. The econometric results stress the key role of international trade in the development of the Eurodollar activities during these years. Implications of these results for the regulation of Euromarkets are briefly considered in the conclusion.