Masaryk university Faculty of Economics and Administration Study programme: European Studies and Economic Policy THE ROLE OF TARGET2 IN EUROPEAN DEBT CRISIS Úloha TARGET2 v Európskej dlhovej kríze Bachelor thesis Supervisor: Author: Ing. Jan JONÁŠ, Ph.D. Soňa SIVÁ Brno, 2019 Author’s first and last name: Soňa Sivá Name of the bachelor thesis: The role of TARGET2 in European debt crisis Department: Department of Economics Supervisor: Ing. Jan Jonáš, Ph.D. Year of defense: 2019 Anotácia Predmetom bakalárskej práce „Úloha TARGET2 v Európskej dlhovej kríze“ je analýza úlohy, ktorú zastáva mechanizmus TARGET2 v kríze, ktorá zasiahla Eurozónu v roku 2008 a ktorej následky trvajú dodnes. Bakalárska práca vysvetľuje ako vznikajú TARGET2 nerovnováhy a polemiku, ktorá sa vedie ohľadom ich pôvodu, riziku, ktoré z nich vyplýva a možných riešení. Dôraz je kladený predovšetkým na rolu TARGET2 v neúplnej menovej únií. Anotation The goal of the submitted thesis: “The role of TARGET2 in European debt crisis” is to analyse the role played by the TARGET2 mechanism in the crisis which hit the Eurozone in 2008 and impacts of which last until now. This thesis explains how the TARGET2 imbalances arise and polemic about their origin, risks which they represent and possible solutions. The emphasis is put on the role of TARGET2 in an uncomplete monetary union. Keywords TARGET2, Eurozone, ECB, European debt crisis, balance of payment crisis, currency union, imbalances Author's statement I hereby confirm that I am the sole author of the written work The role of TARGET2 in European debt crisis and that I have compiled it in my own words under the supervision of Ing. Jan Jonáš, Ph.D. Furthermore, I confirm that I have clearly referenced all printed and any other sources in accordance with legal regulations and internal regulations of the Masaryk University and the Faculty of Economics and Administration. 18 April 2019 in Brno signa ture Acknowledgements I would first like to thank my thesis advisor Ing. Jan Jonáš, Ph.D. for his valuable comments and guidance which helped me to accomplish this bachelor thesis. I would also like to thank Dr. Dirk Ehnts who devoted me to this topic at Maastricht summer school and gave me motivation to dedicate further time to its research. Finally, I must express my very profound gratitude to my parents and friends for providing me with unfailing support and continuous encouragement throughout my years of study and through the process of writing this thesis. Table of content Introduction ............................................................................................................................. 11 1. Eurozone debt crisis ........................................................................................................ 12 1.1. Evolution of Eurozone debt crisis .............................................................................. 12 1.2. Euro as an amplifier of the crisis ................................................................................ 14 1.3. Imbalances and divergent competitiveness ................................................................ 15 1.4. Alternative interpretation of Euro crisis ..................................................................... 17 2. TARGET2 imbalances .................................................................................................... 18 2.1. Definition of Target2 .................................................................................................. 18 2.2. Central bank balance sheets ....................................................................................... 19 2.3. TARGET2 and monetary operations ......................................................................... 22 2.4. TARGET2 balances and imbalances ......................................................................... 24 2.5. Various interpretations of TARGET imbalances. ...................................................... 26 3. Current account transactions and TARGET2 .............................................................. 28 3.1. Balance of payments .................................................................................................. 28 3.2. A balance of payment crisis in fixed exchange rate regime ....................................... 30 3.3. A balance of payment crisis in the Eurozone ............................................................. 31 4. Discussion of possible solutions ...................................................................................... 33 4.1. Risk emerging from TARGET2 balances .................................................................. 33 4.2. Settlement of TARGET2 balances ............................................................................. 36 4.3. Possible solutions of imbalances ................................................................................ 37 Conclusion ............................................................................................................................... 40 References: ............................................................................................................................... 42 List of figures: .......................................................................................................................... 45 List of tables: ........................................................................................................................... 46 Introduction European debt crisis revealed more than fiscal indiscipline of the periphery countries. It revealed also that European Monetary Union (EMU) without fiscal union has many shortcomings. Eurozone members are economically diverse and, in this context, we use to distinguish between periphery and core countries. The two part of the Union started to diverge even few years before the crisis emerged which can be seen at the current account imbalances. After the outbreak of the financial crisis in the European Union, TARGET2 balances also started to evolve in divergent directions which called attention of economics and provoked a discussion about its causes and risks which they imply. The discussion was opened by Sinn and Wollmershäuser in 2011 and, since then, many economists of different theoretical background published articles about TARGET2. And most of them opposed to Sinn and Wollmershäuser. The TARGET2 is relatively new topic which had not occurred in discussions until the start of the European debt crisis. However, it represents an interesting theme worth profound and long- lasting discussions since it shows the negative sides of an uncomplete monetary union as the Eurozone. Furthermore, an amount of accumulated imbalances is enormous which impose a risk on touched countries, in particular Germany. The main objective of the thesis is to examine the role of the TARGET2 mechanism in an incomplete monetary union in the context of the European debt crisis and taking specific features of the Eurozone incomplete integration into account. Furthermore, it aims to discuss the risk exposure of the countries holding large TARGET2 claims and to provide possible scenarios and solutions for the future. The first chapter aims to provide a reader with the most important facts about the evolution of European debt crisis and related internal imbalances within the Eurozone, which are fundamental for understanding the origin of TARGET2 imbalances and their potential solutions. The second chapter explains the TARGET2 payment system and its balances on simplified examples of the payment transaction between Euro member states. It further presents the origin of accumulated TARGET2 imbalances and their interpretations by different authors. The third chapter lays out the basis for understanding TARGET2 balances in the context of balance of payment and the role of such a system in the balance of payment crisis while comparing Eurozone with fixed exchange rate regimes. Analysis of risk exposure emerging from such imbalances is to be found in the last chapter together with a layout for potential solutions to imbalances within Eurozone. 11 1. Eurozone debt crisis Even though the TARGET2 was introduced few years before the start of the Euro crisis, its characteristics had not come to the surface until the start of the European debt crisis. This thesis does not offer a detailed description of the causes of Euro crisis, but some facts are important to emphasize before the start of the TARGET2 analysis. A focus will be put on the role of common currency as well as internal imbalances within Eurozone member states. 1.1. Evolution of Eurozone debt crisis European Union is currently facing the impacts of sovereign debt crisis which starting point is dated back to the end of 2009, the aftermaths of the world financial crisis, when some of the European periphery states – Greece, Italy, Ireland, Portugal and Spain (GIIPS) – have plunged into insolvency problems and became unable to repay their debts. The causes of the crisis reside in preceding credit booms in the periphery states due to joining the Eurozone, related financial liberalization and dynamic global financial markets in the same period. In this context, a common currency permitted banks to raise funds from international institutions in their currency. Related low interest rates and easily available credit resulted in increased borrowing. (Lane 2012, p. 52) The capital was flowing out from the core countries, in particular Germany and Netherlands, to the periphery which led to economic boom, mainly