Target2: The Silent Bailout System that Keeps the Euro Afloat

66 Pages Posted: 31 May 2018

See all articles by David P. Blake

David P. Blake

City University London - Cass Business School

Date Written: May 22, 2018

Abstract

Target2 is the Eurozone’s cross-border payment system and is mandatory for the settlement of euro transactions involving Eurozone central banks. It is being used to save the Eurozone from imploding.

A key underlying problem is that the Eurozone does not satisfy the economic conditions for being an Optimal Currency Area, a geographical area over which a single currency and monetary policy can operate on a sustainable long-term basis. The different business cycles in the Eurozone, combined with poor labour and capital market flexibility, mean that systematic trade surpluses and deficits will build up – because inter-regional exchange rates can no longer be changed.

Surplus regions need to recycle the surpluses back to deficit regions via transfers to keep the Eurozone economies in balance. But the largest surplus country – Germany – refuses formally to accept that the European Union is a ‘transfer union’. However, deficit countries including the largest of these – Italy – is using Target2 for this purpose.

Further, the size of the deficits being built up is causing citizens in deficit countries to lose confidence in their banking systems and they are transferring funds to banks in surplus countries. Target2 is also being used to facilitate this capital flight.

However, these are not viable long-term solutions to systemic Eurozone trade imbalances and weakening national banking systems. There are only two realistic outcomes. The first is full fiscal and political union – which has long been the objective of Europe’s political establishment. The second is that the Eurozone breaks up.

Keywords: Target2, payment system, Optimal Currency Area, Eurozone, euro

JEL Classification: E02, E42, F45

Suggested Citation

Blake, David P., Target2: The Silent Bailout System that Keeps the Euro Afloat (May 22, 2018). Available at SSRN: https://ssrn.com/abstract=3182995 or http://dx.doi.org/10.2139/ssrn.3182995

David P. Blake (Contact Author)

City University London - Cass Business School ( email )

London, EC2Y 8HB
Great Britain
+44 (0) 20-7040-5143 (Phone)
+44 (0) 20-7040-8881 (Fax)

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