The dollar as an official reserve currency under EMU

Abstract

This article analyzes official reserve-holding behavior in EU countries to assess the effect EMU might have on holdings of dollar reserves. Based on earlier research and new estimates, a wide range of projections is presented for the effect of EMU on the overall demand for reserves and their currency composition. It is argued that official dollar holdings could decline on the order of 35% or more from current dollar holdings, although the range of uncertainty is quite large. The contributions of country-specific factors appear to swamp the systematic components that had been isolated in earlier research. Copyright Kluwer Academic Publishers 1996reserves, central banks, EMU, currency composition, E58, F33, F36,

Characteristics of the Euro, the Demand for Reserves, and Policy Coordination Under EMU

“…However, demand for reserves will also decline, since much of what was foreign trade will be trade between members of the monetary union, and should therefore not be associated with reserve holdings. There have been various calculations of the net effect of those two factors, with all authors agreeing that existing dollar reserves are greater than will be needed after EMU-see European Commission (1990), Kenen (1993), Leahy (1996), among others. Their calculations have been based only on estimates of current holdings, not actual data, since figures for individual countries are not made public.…”

“…The European Commission's calculation makes no allowance for the reduction in the holdings of other EU currencies as reserves, and it also includes gold, which is arguably not held for the same reasons as currencies. In contrast, Leahy (1996) cites a figure of a possible decline in dollar holdings to 65 percent of what they were, which using 1992 reserve levels would translate into a decline in dollar holdings of$55 billion.…”

“…There are a number of uncertainties involved in such calculations, as detailed by Leahy (1996). First is the issue of whether there are economies of scale that operate as a result of pooling of reserves, allowing the European Central Bank to economize further on reserve holdings relative to the national central banks at present.…”

The Euro and International Capital Markets

“…Long before the official introduction of the euro on 1 January 1999 an intensive debate picked up about what the potential consequences of European Monetary Union (EMU) could be for the international monetary and financial system (European Commission/ Emerson et al, 1990;Alogoskoufis and Portes, 1993;Bénassy et al, 1994;ECU Institute/Thygesen et al, 1995;Frankel, 1995;Kenen, 1995, chapter 5;Hartmann, 1996;Leahy, 1996;Bergsten, 1997;Henning, 1997;International Monetary Fund/Masson et al, 1997;BIS, 1997a/McCauley, 1997; OECD/ Funke and Kennedy, 1997;Cohen, 1998;Eichengreen, 1998;Wyplosz, 1999). Considerable diversity of views on numerous aspects notwithstanding, many participants' opinion in that debate converged towards the view that the currency choices in international capital markets would be key for the issue at stake (Bergsten, 1997;McCauley, 1997;Hartmann, 1998c;Portes and Rey, 1998).…”

Key Currencies After the Euro

“…Estimates of redundancy vary, since our understanding of the official demand for reserves remains imperfect, but Leahy (1994) has produced a not-veryconfidently held average redundancy of 35 percent. If EMU members were to unload these reserves, mainly dollar-denominated, that would exert a major impact on foreign exchange markets, appreciating the euro relative to the dollar.…”