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 i t 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 mark et with sufficient stability to be attractive to international investors re quires continuous liquidity management and periodic lender-of-last-resort o perations by the issuing central bank. That the Maastricht Treaty assumes a strong separation between monetary policy and prudential regulation conseq uently bodes ill for the euro's prospects as a reserve currency. (C) 1998 A cademic Press.