Working Paper: NBER ID: w13909
Authors: Menzie D. Chinn; Jeffrey A. Frankel
Abstract: The euro has arisen as a credible eventual competitor to the dollar as leading international currency, much as the dollar rose to challenge the pound 70 years ago. This paper uses econometrically-estimated determinants of the shares of major currencies in the reserve holdings of the world's central banks. Significant factors include: size of the home country, rate of return, and liquidity in the relevant home financial center (as measured by the turnover in its foreign exchange market). There is a tipping phenomenon, but changes are felt only with a long lag (we estimate a weight on the preceding year's currency share around .9). The equation correctly predicts out-of-sample a (small) narrowing in the gap between the dollar and euro over the period 1999-2007. This paper updates calculations regarding possible scenarios for the future. We exclude the scenario where the United Kingdom joins euroland. But we do take into account of the fact that London has nonetheless become the de facto financial center of the euro, more so than Frankfurt. We also assume that the dollar continues in the future to depreciate at the trend rate that it has shown on average over the last 20 years. The conclusion is that the euro may surpass the dollar as leading international reserve currency as early as 2015.
Keywords: Euro; Dollar; International Currency; Reserve Currency; Econometrics
JEL Codes: E42; F00; F02; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tipping phenomenon (F16) | rapid shifts in currency dominance (F31) |
| size of the home country (R12) | currency shares (F31) |
| financial market liquidity (G10) | currency shares (F31) |
| lagged currency shares (F31) | current currency shares (F31) |
| depreciation of the dollar (F31) | confidence in the dollar's value (F31) |
| currency shares (F31) | future dominance of the euro and dollar (F01) |