Given its need to instil confidence in the markets and to ensure the stability of the euro exchange rate, the European central bank is likely to want to be perceived as ready and able to operate effectively in the dollar market, for which substantial dollar reserves may be required. In the short term, the response of non-European central banks to the introduction of the euro is also likely to be cautious. Ultimately, the desired euro holdings of these central banks will largely depend on the decisions they make about their exchange rate regime. A number of countries -- including the central European countries that have applied for membership in the European Union and other countries in Africa -- may decide to peg their currency to the euro. Yet these countries may well wait for the newly-formed European central bank to establish its policy record and clarify its operating procedures before they commit their currencies to a euro peg. Indeed, history suggests that a currency’s role as an international reserve, means of exchange, and store of value is slowly gained and slowly lost -- as the examples of the dollar and pound sterling illustrate. The dollar, in particular, may have seemed on the way to losing much of its international prominence after the demise of the Bretton Woods system in 1973. After declining as a share of international reserves and a means for international transactions from 1974 to the mid-1980s, however, the dollar’s relative use has not changed significantly during the past decade.
By contrast, American policymakers might have found it helpful to devalue the dollar in Texas when oil prices collapsed in the mid-1980s or the dollar in New England at the end of the defense-led growth of the late 1980s. These options, however, simply were not available. In retrospect, it was the discipline fostered by the absence of the opportunity to alter regional exchange rates that forced our firms, local governments, and workers to reorganize, become more efficient, and grow in what are now some of the most productive areas of the United States. Similarly, if national labor markets in Europe become more flexible and efficient in the presence of a common currency and firms learn to count only on their own resources -- with no help from an occasional exchange rate adjustment -- European capital and labor markets may themselves become more integrated. And if greater integration of labor markets can only proceed slowly -- given persistent and unavoidable cultural and language differences -- this need not be the case for financial markets, where the disappearance of exchange rate risk will cause capital to move in response to interest rate differentials of only a very few percentage points. In this context, I would like to make clear that I do not view as ideal the U.S. model where the burden of recessions tends to fall heavily on the shoulders of workers, who may be obliged to move across regions and industries in response to the business cycle.