Why is the euro punching below its weight?

SUMMARY On the twentieth anniversary of its inception, the euro has yet to expand its role as an international currency. We document this fact with a wide range of indicators including its role as an anchor or reference in exchange rate arrangements – which we argue is a portmanteau measure – and as a currency for the denomination of trade and assets. On all these dimensions, the euro comprises a far smaller share than that of the US dollar. Furthermore, that share has been roughly constant since 1999. By some measures, the euro plays no larger role than the Deutschemark and French franc that it replaced. We explore the reasons for this underperformance. While the leading anchor currency may have a natural monopoly, a number of additional factors have limited the euro’s reach, including lack of financial centre, limited geopolitical reach and US and Chinese dominance in technology research. Most important, in our view, is the comparatively scarce supply of (safe) euro-denominated assets, which we document. The European Central Bank’s (ECB's) lack of policy clarity may have also played a role. We show that the euro era can be divided into a ‘Bundesbank-plus’ period and a ‘Whatever it Takes’ period. The first shows a smooth transition from the European Exchange Rate Mechanism and continued to stabilize German inflation. The second period is characterized by an expanding ECB arsenal of credit facilities to European banks and sovereigns.