Speaking in London at the launch of EMU: Prospects and Challenges for the Euro, Portes said:

• The development of euro financial asset markets and network (‘thickness’) externalities among euro users in forex markets will support the euro’s role as an international currency. As euro securities markets become deeper and more liquid and transactions costs fall, euro assets will become more attractive, so the use of the euro as a vehicle currency in forex markets will grow; the two effects interact, and that synergy will bring the euro to challenge the dollar.
• Previous work focused on private invoicing behaviour, official reserve holding behaviour, and the use of the euro as an anchor currency (pegging) – according to the new analysis, all these will be secondary to the financial and forex market interactions.
• The Portes-Rey calculations show that if financial market integration in Europe progresses sufficiently, the ‘fundamentals’ of international trade and investment could support either a ‘medium euro’ or a ‘big euro’ scenario. In both, the euro would replace the dollar as the main international currency for financial asset transactions (except between the US and Asia), but only in the ‘big euro’ scenario would the euro also take on the forex market vehicle currency role.
• The consequence could be a welfare gain of 0.5% of GDP (annually) for Europe, with a similar loss for the US – as well as the other economic and geopolitical attributes of the ‘hegemonic’ world currency.
• The transition period will see substantial portfolio shifts from dollar-denominated into euro-denominated assets, possibly creating excess demand for the latter. That would favour a ‘strong’ euro.
• To promote the internationalisation of the euro, European policy-makers should focus their efforts on integrating European capital markets. Deregulation and policy harmonisation (for example, in government bond issuing) as well as private market initiatives could enhance the liquidity, breadth and depth of these markets. So measures that would improve the financial environment for savers and investors in the euro region would also support the euro’s challenge to the dollar.
• The early period could see considerable instability associated with the emergence of the euro, especially if the United States were to resist any decline in the international status of the dollar. The European authorities will have to take account of these instabilities and exchange-rate pressures in setting their monetary policies, and this may make simple policy rules inadvisable. Better international macroeconomic policy coordination may be necessary to mitigate the destabilising effects.

We gratefully acknowledge the support of Salomon Smith Barney in launching this book.

EMU: Prospects and Challenges for the Euro is a special issue of the review, Economic Policy: A European Forum. It contains revised versions of the papers presented to the Twenty-Sixth Economic Policy Panel Meeting held in Bonn on 17/18 October 1997, with the support of the Zentrum für Europäische Integrations-forschung. The Economic Policy Panel meets twice annually to discuss papers that are specially commissioned by the editors to provide timely and authoritative analyses of the choices confronting policy-makers. The articles use the best of modern economic analysis, but are easily accessible to a wide audience and highly readable. Each paper is discussed by a rotating Panel of distinguished economists whose comments are published to provide the reader with alternative interpretations of the evidence and a sense of the liveliness of the current debate.

Economic Policy is published in association with the European Economic Association for the Centre for Economic Policy Research, the Center for Economic Studies of the University of Munich and the Département et Laboratoire d’Economie Théorique et Appliquée (DELTA), in collaboration with the Maison des Sciences de l’Homme.

Richard Portes is Professor of Economics at London Business School and President of the Centre for Economic Policy Research. He is a Senior Editor of Economic Policy.Hélène Rey is a lecturer in economics at the London School of Economics.

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