The International Reserves Issue in the EMU

This paper examines the effects of the Economic and Monetary Union on demand for foreign reserves. The traditional theory on demand for international reserves assigns a pivotal role to imports. However, in a currency union part of imports are settled in the common currency, leaving no incentive for keeping foreign reserves. Moreover, the pooling of the demand for reserves in the currency union and an increasing role of a currency as an international reserve currency may also influence, among other things, the union demand for reserves. Based on estimated demand functions for reserves it is shown that the Economic and Monetary Union has reduced the demand for reserves substantially. It is argued that an enlargement with new member countries of the European Union will result in further savings of reserves. A simple calculation at the end of the paper illustrates the welfare gain associated with the reduced need of reserves in the Economic and Monetary Union.