October 17, 2012
Over the past one and a half years the debate over the economic interpretation of TARGET2 balances has been causing considerable controversy. The minimum consensus seems to be that they reflect balance-of-payments imbalances within the euro area. TARGET2 balances are pushed up by both current account imbalances and uneven capital flows.
In the absence of private capital imports needed to fund current account deficits, the peripheral countries were forced into the role of debtor in the TARGET2 system, while countries with current account surpluses - Germany, in particular - became creditors. However, there were considerable differences between the TARGET2 deficit countries. Ireland and Portugal, for instance, were on a positive trend with aid programmes launched at end-2010 and in spring 2011, respectively, and a determined reduction of economic imbalances. Since last year, Portugal has managed to contain its deficits. Ireland has reduced its deficit by almost EUR 50 bn from an all-time high at the end of 2010. Things are looking quite different for Greece, however. Despite receiving financial assistance from two programmes, Greece's liabilities in the TARGET2 system have increased to EUR 108 bn. But the speed at which the deficit has grown has also slowed in Greece since the aid programmes were launched. The ongoing increase in TARGET2 imbalances has recently been driven almost exclusively by Spain and Italy.
In relation to GDP, liabilities in TARGET2 are highest in Ireland (60%) and Greece (52%). Spain has caught up with Portugal and both countries now post a TARGET2 deficit in relation to GDP of roughly 40%. By comparison, Italy's 18% deficit looks downright small. Germany boasts a TARGET2 surplus of 27% of GDP.
The ECB's announcement of a new OMT programme (outright monetary transactions) and the coming into force of the European Stability Mechanism (ESM) initially had a calming effect on the financial markets. Capital outflows from the deficit countries slowed noticeably. Whether the decline in TARGET2 liabilities in September already marks the hoped-for trend reversal remains doubtful, though. Like so many other things during the current crisis, it depends on the degree to which the peripherial countries can reduce their current account deficits.