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

  • Gabriele Galati
  • Philip D. Wooldridge

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.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 218.

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Length: 35 pages
Date of creation: Oct 2006
Date of revision:
Handle: RePEc:bis:biswps:218
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