We propose a new analytical basis for discussing the potential international role of the euro and offer specific estimates of its consequences.

Previous work on the costs and benefits of a European international reserve currency (e.g., Alogoskoufis and Portes 1991, 1992, 1997) has considered many issues: seigniorage, benefits for ‘home’ financial institutions, relaxation of the ‘external constraint’ on macroeconomic policy, the role of the region in international institutions, effects on macroeconomic policy coordination, and the wider consequences of exercising or sharing ‘currency hegemony’. Here we assess whether the euro will take on this role, we measure the effects of alternative scenarios on welfare in the main world regions, and we consider European policy options.

We stress developments in financial asset markets, and we use a new model and new data to evaluate scenarios. As euro securities markets become deeper and more liquid and transactions costs fall, euro assets will become more attractive, and the use of the euro as a vehicle currency will expand; the two effects interact. The welfare analysis reveals potential benefits for the euro area, of the same order of magnitude as international seigniorage - at the cost of the US and the ‘Asian bloc’.

If policy-makers wish to promote the international role of the euro, they should focus their efforts on integrating the European capital markets: increasing their liquidity, breadth, and depth. Here both (de)regulation and various aspects of policy harmonisation across Europe will be important; so also will be private market initiatives (e.g. in establishing benchmark interest rates and securities).

'The emergence of the euro as an international currency, (with H.Rey), Economic Policy 26, April 1998, 305-343

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