The euro as a reserve currency

This paper presents historical and econometric evidence that the euro will come to rival the dollar as a reserve currency only slowly. The fact that it pays for central banks to hold their foreign reserves in a currency that is widely used in international transactions creates a network externality that gives the dollar an incumbency advantage. In addition, creating a market with sufficient stability to be attractive to international investors requires continuous liquidity management and periodic lender-of-last-resort operations by the issuing central bank. That the Maastricht Treaty assumes a strong separation between monetary policy and prudential regulation consequently bodes ill for the euro's prospects as a reserve currency. (C) 1998 Academic Press.