Implications of Reducing the Eurosystem´s Excess Reserves

Recent estimates suggest that international reserve holdings of the eurosystem could be reduced to half of its existing level as a result of the introduction of the euro. The two main arguments usually put forward are the disappearance of a large part of international trade (intra euroland trade became "regional" trade) and the elimination of the need to stabilise the exchange rate vis-à-vis the currencies of other euroland countries. Other arguments relate to the existence of "economies of scale" in the demand for international reserves and optimum currency area arguments. While the exact amount of excess reserves in the eurosystem remains controversial, most economists would probably agree that the reserve holdings of the eurosystem are in excess of what would be regarded as "adequate" for such a large currency area. There is, however, little or no consensus about the best way to run down these excessive reserve holdings; actually, there are hardly studies trying to answer this question. This study shall help to close this gap in the literature by analysing the potential costs and benefits, involved in alternative ways to reduce reserves to an adequate level. Potential (gross) welfare gains have to be balanced against a reduction in the yield earned on reserves on one hand and against potential threats for price- and exchange rate stability on the other hand. The latter aspects also matter from a legal point of view, as certain reserve transactions (like significant reductions) by the national central banks (NCBs) require the approval of the European Central Bank (ECB), which may be refused in case of their inconsistency with the exchange rate and the monetary policies of the Community. Generally, economic and legal aspects of the research project are interrelated to a large extent, requiring an interdisciplinary approach in pursuing the following main goals: -to provide a systematic overview of the proposed alternatives to use excessive reserve holdings and an analysis of the problems involved in allocating excessive reserves to the countries of the euro area. -based on existing estimates of the size of excess reserves, to analyse the economic implications of alternative reserve uses. -to analyse the legal framework and the distribution of powers between the various actors (ECB, NCBs, governments) on the European and national level. -to discuss the consistency of the proposed alternatives with the legal framework and potential legal conflict settlement procedures between the ECB and the national governments.

Since the introduction of the Euro on 1 January 1999 part of the Euroystem`s international reserves can be regarded as excessive. Estimates suggest that this excess amounts to approximately one third to half ( ($130 - $170 bill.) of the existing reserve level (end 2001). Due to the different reserve endowments of the euro area countries, relative excess reserves differ widely across countries, ranging from 40 (GR) to 75 (PT) per cent in terms of shares in own reserves. The question, whether and how to run down theses excessive reserves, has been part of intensive debates between politicians and central bankers since then. As central banks are only entrusted with the management of international reserves on behalf of the countries, a democratically legitimated political will to use these excess reserves in alternative ways (instead of a continued management by the central banks) cannot be rejected in principle. Proposals range from a use of reserves for a repayment of public debt, the financing of a public fund for the support of research, education (or most recently: emergency aid) to financing of a tax reform. The choice among these variants is ultimately a political decision. Objectively, some basic economic and legal conditions have to be taken into account. From an economic point of view, one has to consider that reserves (except most of gold reserves) are interest bearing; part of this revenue is transferred to the government`s budget anyway; the utility of alternative uses thus has to be higher than this yield earned on reserves. Generally, the expected economic gains are of a moderate size; in the case of a use for debt repayment it would amount to 0.1% of GDP per annum (average of EU-12). Furthermore, the reduction of reserves to its adequate level would eliminate some conflicts of interest between monetary and investment policy and restrict the central banks fields of operation to its core task: the conduct of monetary policy. From a legal perspective it can be stated, that reserve reductions effected by a transfer of an extraordinary gain to the state do not constitute monetary financing as prohibited under Art 101 of the EC- treaty; being qualified as a financial transaction in several decisions by Eurostat, however, it would not be eligible to lower the deficit against the background of the excessive deficit procedure. As there are no explicit rules for a reserve reduction, one has to assume an analogous application of Art 31 of the ESCB Statute, which states that reserve transactions above a certain threshold require the ECB`s approval. Such an approval could only be rejected, if the envisaged measures were found to be inconsistent with the ECB`s monetary and exchange rate policy. This decision is subject to control by the European Court of Justice (ECJ). However, bringing this issues before the ECJ is to be avoided from a perspective of monetary policy, if a deterioration in confidence in the Euro shall be avoided. Taken altogether, the moderate gains, the fact that there is no threat for financial stability, and that also from a legal perspective, changes to the current status seem admissible, an adjustment of the reserve level can be supported from an economic and legal perspective. Serious negotiations between the finance ministers and the central bankers should be taken up soon in order to provide an economically, legally as well as politically smooth process for the eventual reserve reductions. That such a consensus solution is basically possible, is shown by the relative conflict-free reduction of the Swiss gold reserves after the removal of the Swiss franc`s link to gold in the year 2000.