Fiscal Divergence, Current Account and TARGET2 Imbalances in the EMU

University of Leipzig Working Paper No. 105

31 Pages Posted: 29 Mar 2012

See all articles by Jose Abad

Jose Abad

Institute for Economic Policy - University of Leipzig

Axel Loeffler

Deutsche Bundesbank

Gunther Schnabl

University of Leipzig - Institute for Economic Policy

Holger Zemanek

University of Leipzig - Institute for Economic Policy

Date Written: March 26, 2012

Abstract

The paper scrutinizes the reasons for the European debt crisis, the implications for TARGET2 imbalances and options for surplus liquidity absorption within an asymmetric EMU. It is argued that starting from the turn of the millennium diverging fiscal policy paths and diverging unit labor costs were the driving force of rising intra-European current account imbalances within the euro area. This was facilitated by post-2001 low interest rate policies and changing financing conditions for the German banking sector. The paper shows how since the outbreak of the crisis the adjustment of intra-EMU current account imbalances is postponed by a rising divergence of TARGET2 balances, as the repatriation of private international credit and deposit flight from the crisis economies is substituted by central bank credit. Given that this process has brought Deutsche Bundesbank into a debtor position to the domestic financial system, we discuss options for liquidity absorption by Deutsche Bundesbank to forestall asset price bubbles in Germany. We argue that economic recovery in periphery countries is key for a reduction of TARGET2 imbalances and therefore surplus liquidity in Germany.

Keywords: EMU, fiscal divergence, TARGET2, current account imbalances

JEL Classification: E42, E52, E58, F32

Suggested Citation

Abad, Jose and Loeffler, Axel and Schnabl, Gunther and Zemanek, Holger, Fiscal Divergence, Current Account and TARGET2 Imbalances in the EMU (March 26, 2012). University of Leipzig Working Paper No. 105 . Available at SSRN: https://ssrn.com/abstract=2030706 or http://dx.doi.org/10.2139/ssrn.2030706

Jose Abad

Institute for Economic Policy - University of Leipzig ( email )

Institute for Economic Policy
Grimmaische Straße 12
Leipzig, 04109
Germany

HOME PAGE: http://www.wifa.uni-leipzig.de/iwp/

Axel Loeffler

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Straße 14
Frankfurt am Main, 60431
Germany
+49 69 9566 2966 (Phone)

HOME PAGE: http://www.bundesbank.de

Gunther Schnabl (Contact Author)

University of Leipzig - Institute for Economic Policy ( email )

Institute for Economic Policy
Grimmaische Straße 12
Leipzig, 04109
Germany

HOME PAGE: http://www.wifa.uni-leipzig.de/iwp/

Holger Zemanek

University of Leipzig - Institute for Economic Policy ( email )

Institute for Economic Policy
Grimmaische Strasse 12
Leipzig, 40109
Germany

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