The European Monetary Union is stuck in a severe balance-of-payments imbalance. The European sovereign debt crisis, which followed the financial crisis, is present in the media, in politics and important economists try to evaluate the situation, in order to find possible solutions.
This paper deals with the TARGET balances. TARGET2 is a payment system in the European Monetary Union, and, as will be shown, the TARGET balances are a measure for the balance- of-payment deficits and surpluses in the countries of the Eurozone. The issue is interesting as there are huge differences in the current account balances of member states. To understand the emergence of the TARGET balances , it is important to first look at the way a central bank creates money. This paper aims to show how TARGET balances arise when trade flows are not financed through inverse capital flows. Further on, it examines the current account deficits of Greece, Ireland, Italy, Portugal and Spain and shows how they led to tremendous TARGET2 debts of those countries. On the other hand it examines, how particularly Germany, to a smaller extend also Finland, Luxembourg and the Netherlands accumulated high TARGET2 claims towards the Eurosystem. Further on, it examines the development of the monetary bases in the Eurozone and how this affected Bundesbank money creation.
Finally, it deals with some concerns regarding the TARGET balances . As it is a complex matter, opinions about their risk diverge. Some analysts think that they are highly problematic, others don’t see any risk at all. Some main ideas dealing with the risk involved will be presented in brief.
Table of Contents
1 The European Sovereign Debt Crisis
2 Money Creation and TARGET balances
2.1 How Does a Central Bank Create Money?
2.2 What is TARGET2 All About?
2.2.1 Purchase Within a Country of the Eurozone
2.2.2 Purchase Between Two Countries of the Eurozone as an Illustration
3 TARGET balances in the GIIPS Countries
3.1 Before Summer 2007
3.2 After Summer 2007
4 Reprinting Money
4.1 Development of the Monetary Bases
4.2 Money Creation in the GIIPS
4.3 Modified Example from Section 2.2.2
4.4 TARGET Balances Crowding Out Bundesbank Money Creation
5 Why are the TARGET balances Problematic?
5.1 Boosting the Crisis and Lack of Legitimization
5.2 What is the Risk for Germany?
5.2.1 Liability in Case of Bankruptcy
5.2.2 Inflation in Germany?
6 Conclusions and Outlook
Research Objectives and Core Themes
This paper examines the emergence, mechanisms, and potential risks associated with TARGET2 balances within the European Monetary Union. It specifically investigates how these balances reflect balance-of-payments deficits and surpluses, how they affect money creation processes within the Eurosystem, and what implications these dynamics hold for the financial stability of Germany and other member states.
- The mechanics of money creation by central banks and the definition of TARGET2.
- The relationship between current account imbalances and the accumulation of TARGET2 claims and liabilities.
- The impact of the financial crisis and the collapse of the interbank market on monetary flows.
- The "crowding out" effect of outside money on domestic refinancing operations (specifically in the Bundesbank).
- An evaluation of economic risks, including liability exposure and potential inflationary pressures.
Excerpt from the Book
Purchase Between Two Countries of the Eurozone as an Illustration
The situation is a bit different when the Greek olive oil producer wants to acquire a German automobile. The money now flows through the ECB’s TARGET2 system. In a very simplified way, tables 2 and 3 show how this transaction affects the balance sheets of the concerned NCBs. Assuming the automobile costs 100 euros: to process the payment, the Greek central bank subtracts the 100 euros from the account of the oil producer’s bank and forwards the payment order to the Bundesbank. There, the 100 euros will be added to the account of the automobile manufacturer’s bank. The “real-time processing . . . and immediate finality” (TRICHET 2011, 26) of TARGET2 are achieved through an automated credit from the Bundesbank to the Greek central bank. The TARGET2 liability of Greece is thus “a public credit provided to this country via the Eurosystem, and a Target claim of a country is a credit given to the Eurosystem – a public credit enabling the beneficiaries to buy foreign assets or goods" (FRANKEL 2008, 9). And as it is a public credit, one has to pay an interest rate for a TARGET2 liability, which is the same rate as the ECB’s main refinancing facility (cf. ABAD and LOEFFLER, et al. 2012, 8ff.).
Summary of Chapters
1 The European Sovereign Debt Crisis: Introduces the background of the European Monetary Union's balance-of-payments issues and outlines the scope of the paper regarding TARGET2 balances.
2 Money Creation and TARGET balances: Explains the theoretical framework of inside and outside money and how TARGET2 functions as a settlement system for cross-border transactions.
3 TARGET balances in the GIIPS Countries: Analyzes the historical progression of TARGET balances from the pre-crisis era to the subsequent collapse of the interbank market.
4 Reprinting Money: Investigates the development of monetary bases and demonstrates the crowding-out effect where TARGET2-related inflows replace domestic refinancing operations.
5 Why are the TARGET balances Problematic?: Addresses critical concerns regarding the lack of democratic legitimization, fiscal burden sharing, and potential economic risks for Germany.
6 Conclusions and Outlook: Summarizes the findings on TARGET2 and discusses the broader implications for the future integration of the European Monetary Union.
Keywords
TARGET2, European Sovereign Debt Crisis, Eurosystem, Central Bank, Money Creation, GIIPS, Current Account, Balance of Payments, Bundesbank, Monetary Policy, Financial Stability, Internal Devaluation, Capital Flight, Refinancing Operations, Fiscal Policy
Frequently Asked Questions
What is the primary focus of this research?
The research focuses on the functioning and economic implications of TARGET2 balances within the Eurozone, specifically in the context of the European sovereign debt crisis.
What are the central themes discussed in the paper?
Key themes include the mechanism of central bank money creation, the substitution of private capital flows by public credit via TARGET2, and the resulting financial dependencies between Eurozone countries.
What is the main research question or objective?
The objective is to explain how TARGET2 balances emerge, why they have reached such high levels in countries like Germany, and whether these balances pose a tangible financial risk to the Eurosystem.
Which scientific methods are employed?
The paper uses a descriptive and analytical approach, combining central bank balance sheet analysis with macroeconomic theory to trace the flow of money through the TARGET2 system.
What is covered in the main body of the work?
The main body details the operational mechanics of cross-border payments, the historical shift in TARGET balances after 2007, and the analysis of how these flows influenced domestic monetary bases and refinancing operations.
Which keywords characterize this paper?
The most defining keywords are TARGET2, Eurosystem, Balance of Payments, Money Creation, GIIPS, and Financial Stability.
How does the "crowding out" effect work in this context?
The paper demonstrates that as TARGET2 inflows increase, commercial banks receive liquidity that reduces their need to borrow from their national central bank, effectively shifting the central bank's role from a net lender to a net creditor.
Does the author conclude that TARGET2 balances pose a direct inflation risk for Germany?
The author notes that while there is no evidence of consumer price inflation, the large influx of liquidity has contributed to rising asset prices and real estate inflation in Germany.
- Quote paper
- Sebastian Lechner (Author), 2012, The Target Balances in the Euro Area, Munich, GRIN Verlag, https://www.grin.com/document/231692
