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BIS home Publications & research Working Papers The euro as a reserve currency: a challenge to the pre-eminence of the US dollar? by Gabriele Galati and Philip D. Wooldridge
Working Papers No. 218 October 2006Abstract: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.
JEL classification: E58, F30, F31, G11, G15.
Keywords: International currency, foreign exchange reserves, currency
composition, euro, dollar, financial markets.
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