The European Crisis and the Accumulation of TARGET2 Imbalances

Abstract

In the context of the European crisis, TARGET2 payment system of the European Monetary Union (EMU) countries became crucial, reflecting funding stress in the banking systems of most crisis-hit countries. This chapter analyzes the role displayed by TARGET2 in the EMU, a monetary union of 19 sovereign states. Until now, the ECB has assumed a crucial role to overcome the European financial crisis. But, to promote a full economic recovery in Europe, a strong interconnection between single countries’ fiscal policies and the ECB’s autonomous monetary policy is necessary. In this regard, we conclude that, in the medium term, a successful crisis resolution requires more political integration of EMU countries, which should include a fiscal union and a banking union. However, in the short run, a prompt recovery is essential to get out of the trouble, and this requires that surplus countries (especially Germany) expand aggregate demand and let domestic wages and the ensuing internal inflation rate increase.