Target2 Imbalances and the “Demokratieprinzip”: Some Questions


One main effect of the Eurozone crisis has been a dramatic shrinkage in interbank lending, which is the normal source of bank liquidity for routine business operations. In this context, a technical feature of the EMU — the ECB’s so-called Target2 payment system — has taken up the slack, providing a means of moving liquidity to those banks that need it. The result, however, has been major imbalances in the Target2 system, with excess liquidity flowing away from the Eurozone core (Germany, Netherlands, Luxembourg, and Finland) toward the periphery, where it is sorely lacking.

From an official perspective, the resulting Target2 imbalances are unproblematic in themselves, unless the Eurozone were to break down. Only then would there be any real risk that these imbalances (amounting to a 547 billion euro claim on the Bundesbank balance sheet at the end of February) could convert into an unpaid liability that the Bundestag might eventually have to make good on its own. But as Jens Weidmann, President of the Bundesbank, declared last month, he is not worried about Target2 imbalances per se “because I believe the idea that monetary union may fall apart is quite absurd”.

Let’s assume the risk of EMU collapse is remote, even “absurd”. Ironically, part of the reason for this absurdity flows from the incentive structure of Target2 itself. To avoid converting mere “imbalances” into potentially massive “liabilities”, the Eurozone core has a strong incentive to take whatever steps are needed to shore up the periphery and thus make collapse politically “absurd”. This is precisely as it should be, one might say, given the sort of economic interdependence that the currency union was designed to promote.

But it also suggests that the incentive structure at the heart of Target2 already contains elements approaching that of a political union ...

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