Target-2 Masks Reduced Fragmentation

Kim Schoenholtz

By Kim Schoenholtz and Stephen Cecchetti

Were euro area members so inclined, the availability today of specific sovereign securities to back Target-2 balances provides a means to reduce them.

By Kim Schoenholtz and Stephen Cecchetti

The claims of the Bundesbank on the European Central Bank through the Target-2 system are approaching €1tn. What do these claims represent? Are they subsidised German loans to other euro-area countries – primarily Italy, Portugal and Spain? Do they signal further financial disintegration in Europe? Or, as large as these numbers are, are they simply a consequence of the complex mechanics related to the construction of the Eurosystem and how it implements monetary operations?

The answer is two-fold: for the first few years of the euro-area crisis – when German claims peaked at €750bn – imbalances reflected subsidised loans to counter rising financial fragmentation. Between 2008-12, funds shifted from banking systems in the periphery of Europe perceived to be under stress, to banks in the core seen as being relatively stable, creating a web of liabilities and claims among national central banks.

After 2012, the risk of breakup receded, so the interpretation of renewed increases in Target-2 balances has changed. Indeed, the doubling since early 2015 is a natural consequence of how the Eurosystem implements its various asset purchase programmes. Consequently, the impact of the APP expansion on Target-2 balances has concealed a further, if still incomplete, reversal of the financial fragmentation triggered by the euro area crisis several years ago.

Read the full OMFIF article.

Kim Schoenholtz is the Henry Kaufman Professor of the History of Financial Institutions and Markets in the Economics Department and Director of the Center for Global Economy and Business.