The demand for international reserves in the Eurosystem. Implications of the changeover to the third stage of EMU.

In this paper we analyse the implications of the euro for the international reserves in the Eurosystem. Two conceptually different effects of the changeover have to be distinguished: a technical effect that largely arises as a matter of accounting, and a behavioural effect that stems from the fact that the optimal demand of the aggregate Eurosystem is not equal to the sum of the optimal country levels. The technical effect arises from two main sources: the abolishment of the ECU-creating mechanism, and the redefinition of international reserves which precludes (former) reserves that were denominated in euro-currencies. As a result the average reserves of the Eurosystem in 1999 amounted to $287 billion, considerably less than in 1998 ($345 billion). We then derive a reserve demand function for the aggregate Eurosystem using panel data estimation techniques and simulate reserve demand for the situation after the regime shift. The optimal aggregate level of reserves turns out to be some $188 billion, which implies excess reserves in the Eurosystem amounting to approximately $100 billion in the year 1999. We go on by proposing a key by which this excess could be allocated to the individual countries taking the asymmetric distribution of reserves in the Eurosystem into account. Finally we classify and enumerate the proposals for making use of the estimated reserve overhang. (author's abstract)