TARGET2: Understanding the Glue that Keeps the Euro Together

TARGET2 is the intra-euro area payment system. Before the outbreak of the euro crisis, the TARGET2 balances of the individual euro area member countries have always been fluctuating closely around zero. Thus, current account transactions have been financed by corresponding private financial account transactions. At the height of the euro crisis in 2012, TARGET2 liabilities of the five major crisis countries accounted for the first time to roughly 1 trillion euros. At that time a massive capital withdrawal from the crisis countries was cushioned by the Eurosystem through almost unlimited lending to crisis-struck banks. Currently (in 2017), TARGET2 imbalances are reaching a second height, in which for many countries, the 2012 levels are exceeded. The narrative of this episode however differs from the capital flight story of 2012. This time the Eurosystem is actively buying government bonds of euro area member countries within its large-scale asset purchase program. The majority of these bonds are purchased by the national central banks from banks located outside the eurozone which are connected to TARGET2 through an account at another national central bank (such as the German Bundesbank). This chapter aims at giving an economic interpretation to these two episodes. On the one hand, it will be argued that the Eurosystem’s role as lender to banks and governments of distressed economies is responsible for the increase in TARGET2 imbalances and that in both cases the increase in TARGET2 liabilities is an indicator for the unwillingness of financial markets to continue lending to these borrowers. On the other hand, in the absence of such lending, the euro probably would not have survived the crisis.