The Euro as a Reserve Currency: A Challenge to the Pre-Eminence of the US Dollar?

35 Pages Posted: 20 Sep 2007 Last revised: 1 Sep 2009

See all articles by Gabriele Galati

Gabriele Galati

De Nederlandsche Bank

Philip D. Wooldridge

Bank for International Settlements (BIS)

Date Written: October 1, 2006

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.

Keywords: International currency, foreign exchange reserves, currency composition, euro, dollar, financial markets

JEL Classification: E58, F30, F31, G11, G15

Suggested Citation

Galati, Gabriele and Wooldridge, Philip D., The Euro as a Reserve Currency: A Challenge to the Pre-Eminence of the US Dollar? (October 1, 2006). BIS Working Paper No. 218, Available at SSRN: https://ssrn.com/abstract=948148

Gabriele Galati (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Philip D. Wooldridge

Bank for International Settlements (BIS) ( email )

CH-4002 Basel, Basel-Stadt
Switzerland

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