Blog Post

Debate on Target 2: Don’t confuse symptom and disease!

For some time economists have been engaged in an arcane controversy about the significance of the imbalances in the joint settlement system used by eurozone central banks, called Target 2. In a series of contributions, Hans-Werner Sinn of the CESifo research group in Munich has drawn attention to the fact that central banks in the northern […]

By: Date: March 2, 2012

For some time economists have been engaged in an arcane controversy about the significance of the imbalances in the joint settlement system used by eurozone central banks, called Target 2.

In a series of contributions, Hans-Werner Sinn of the CESifo research group in Munich has drawn attention to the fact that central banks in the northern part of the eurozone were accumulating claims on central banks in the southern part via Target 2. From about zero in 2007, these claims have risen to €400bn in 2010 and €800bn lately. Mr Sinn argues that this amounts to backdoor financing of southern Europe and asks for these claims to be settled periodically.

A letter (not yet made public) by the Bundesbank president Jens Weidmann to Mario Draghi, president of the European Central Bank, is set to change the nature of the Target 2 debate and make it a policy issue of major importance. The Frankfurter Allgemeine reports that the Bundesbank would like its Target 2 balances to be collateralised.

Is this imbalance a problem? It is certainly a worrying symptom. But the starting point of any analysis should be the recognition that Target 2 imbalances are not the direct result of current account imbalances. Among eurozone countries, the latter reached their climax in 2007, but they were entirely matched by private capital flows. The Target 2 deficit of the southern eurozone countries has helped finance shrinking current-account deficits but also, and in some cases much more, private capital outflows..

Indeed the eurozone has in recent years experienced “sudden stops” of the sort common in emerging market balance of payment crises. Instead of flowing in, partly through the interbank market, private capital has suddenly started to flow out of southern European countries, including Italy at the end of 2011. Banks unable to access liquidity have turned to the Eurosystem, which has substituted the interbank market, thereby performing its classical role as a lender of last resort. Data on recent access to central bank liquidity confirm that although banks in the whole of the eurozone made use of it, it went disproportionately to southern Europe.

The very notion of a balance of payment crisis within the eurozone was alien to the concept of a monetary union. It was routinely assumed that for countries within it, balance of payments would become as irrelevant as they are between regions within a country. This assumption was wrong. Countries are not regions, largely because much their banking systems are primarily exposed to their sovereign and to domestic borrowers. So when the sovereign is in distress or private borrowers partially insolvent, the banking system is contaminated and there is a stigma attached to being a bank from country X or Y. Foreign lenders become wary and stay put. Target 2 balances largely reflect this counterparty risk.

But a symptom is not a disease. It is the diseases that must be cured. This certainly requires more than letting the fever subside through a huge injection of central bank liquidity. Public finances must be made convincingly sustainable, bad loans on banks’ balance sheets must be provisioned and recapitalisation must take place wherever needed. Furthermore, a lesson from the euro crisis is that excessive credit booms leading to large current account imbalances must be avoided. In the very short term remaining large external deficits such as that of Greece, where it reaches 10 per cent of gross domestic product, must be shrunk. Wherever useful, the European Union should make use of the procedure it recently created to this end.

Only when the diseases are cured will private capital flows return. In the meantime, the Eurosystem is doing its job. It is to be commended for it, and actions that would cast doubt on the future of the euro should be avoided.

A version of this column was also published in the Financial Times The A-List


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Topics

Comments

Read article More on this topic More by this author

Blog Post

Silvia Merler

EU migration crisis: facts, figures and disappointments

Attempts to stem the flow of refugees to Europe have so far had little success. Two months into 2016, we take a detailed look at the numbers of the refugee crisis and the European response.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: February 12, 2016
Read article More on this topic

Opinion

Pia Hüttl
Schoenmaker pic

Why euro-zone ‘outs’ should join banking union

Joining the banking union could provide a stable arrangement for managing financial stability for the UK and other non-Euro countries.

By: Pia Hüttl and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 11, 2016
Read article

Blog Post

IMG_20151009_103117 (3)
Portraits Bruegel staff 2014

Can mass migration boost innovation and productivity?

The long-term impact of migration on innovation and productivity growth in host countries is a neglected issue in the current debate on refugees. Research shows that these effects can be substantial, but if Europe wants to capitalize on this potential it will need better information systems to match migrants’ skill sets with host environments.

By: Nuria Boot and Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: February 10, 2016
Read article More by this author

Parliamentary Testimony

Inquiry of the House of Lords’ EU Financial Affairs Sub-Committee on “Completing Europe’s Economic and Monetary Union”House of Lords

Inquiry of the House of Lords' EU Financial Affairs Sub-Committee

The enquiry on "Completing Europe’s Economic and Monetary Union" took place on 27 January 2016 in Brussels.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance, House of Lords, Parliamentary Testimonies Date: February 8, 2016
Read article More on this topic

Blog Post

Pia Hüttl
Schoenmaker pic

European banking union: should the 'outs' join in?

To address coordination failures between national institutions regulating banks, we need supranational policies. Banking union encourages further integration of banks across borders, deepening the single market, and could also benefit countries outside the euro which have a high degree of cross-border banking.

By: Pia Hüttl and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 4, 2016
Read article Download PDF More on this topic

Policy Contribution

Should the ‘outs’ join the European banking union?

Should the ‘outs’ join the European banking union?

This paper analyses the banking linkages between the nine ‘outs’ and 19 ‘ins’ of the banking union. It finds that the out countries could profit from joining banking union, because it would provide a stable arrangement for managing financial stability.

By: Pia Hüttl and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 4, 2016
Read about event More on this topic

Upcoming Event

22 
Feb
2016
12:30

Economic weakness and demographic challenges: what next for Europe?

After a year of weak recovery what is next for Europe? This event will look at both the general macroeconomic situation as well as the challenges posed by changing demographics

Speakers: John Driffill, Torben M. Andersen and Pia Hüttl Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

The economic consequences of Schengen

The president of the European Commission, Jean-Claude Juncker, recently warned that “without Schengen and the free movement of workers, of citizens, the euro makes no sense.” And in fact, it is the single currency and the ability to travel freely without identity documents that most Europeans associate with the EU. So how does it really stand with Schengen and the euro?

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: February 2, 2016
Read about event More on this topic

Upcoming Event

23 
Feb
2016
12:30

Adjustment in the Economic and Monetary Union

This event will look at shocks and adjustment in the euro area in the light of recent crises and analyse the functioning of a key internal adjustment process in EMU

Speakers: Robert Anderton, Antoine Berthou, José Leandro and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Blaming the Fed for the Great Recession

What’s at stake: Following an article in the New York Times by David Beckworth and Ramesh Ponnuru, the conversation on the blogosphere was dominated this week by the question of whether the Fed actually caused the Great Recession. While not mainstream, this narrative recently received a boost as Ted Cruz, a Republican candidate for the White House, championed it.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: February 1, 2016
Read about event More on this topic

Upcoming Event

25 
Feb
2016
12:30

The long-term impact of migration in Europe

Amidst the short-term drama of the refugee and Schengen crises, it is time to look at the long-term effects of migration on European societies and economies.

Speakers: Pieter Cleppe, Naika Foroutan and Reinhilde Veugelers Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

The fallout from the European refugee crisis

Of the 1.5 million refugees that reached the European Union last year, more than 1 million ended up in Germany, but the initially welcoming atmosphere has changed drastically.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: January 29, 2016
Load more posts