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TARGET Balances and Macroeconomic Adjustment to Sudden Stops in the Euro Area

Author

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  • Gabriel Fagan

    (Institute for International Integration Studies, Trinity College Dublin)

  • Paul McNelis

    (Graduate School of Business Administration, Fordham University, New York)

Abstract

This paper examines how membership of a monetary union affects macroeconomic adjustment of Euro Area countries to sudden stops.We focus on a key difference between a standard peg and a monetary union: the availability of external financing from the common centralbank via the TARGET system. For this purpose, we use a modified version of the Mendoza (2010) model which incorporates central bankfinancing, based on an empirical analysis of TARGET flows. Our results show that the availability of such financing greatly mitigates thecollapse in GDP, consumption and investment during sudden stops (relative to a regime in which such financing is not available). However,a welfare analysis shows that TARGET financing only results in modest welfare gains in the affected country, since it exacerbates thetendency towards over-borrowing, leading to an increased incidence of sudden stop episodes.Length: 68 pages

Suggested Citation

  • Gabriel Fagan & Paul McNelis, 2014. "TARGET Balances and Macroeconomic Adjustment to Sudden Stops in the Euro Area," The Institute for International Integration Studies Discussion Paper Series iiisdp465, IIIS, revised Dec 2014.
    • Handle: RePEc:iis:dispap:iiisdp465
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    References listed on IDEAS

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    Cited by:

    1. Hristov, Nikolay & Hülsewig, Oliver & Wollmershäuser, Timo, 2020. "Capital flows in the euro area and TARGET2 balances," Journal of Banking & Finance, Elsevier, vol. 113(C).
    2. Fagan, Gabriel & McNelis, Paul D., 2020. "Sudden stops in the Euro Area: Does monetary union matter?," Journal of International Money and Finance, Elsevier, vol. 108(C).
    3. Bofinger, Peter & Feld, Lars P. & Schmidt, Christoph M. & Schnabel, Isabel & Wieland, Volker, 2018. "Vor wichtigen wirtschaftspolitischen Weichenstellungen. Jahresgutachten 2018/19 [Setting the Right Course for Economic Policy. Annual Report 2018/19]," Annual Economic Reports / Jahresgutachten, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, volume 127, number 201819.
    4. Scheubel, Beatrice & Stracca, Livio, 2019. "What do we know about the global financial safety net? A new comprehensive data set," Journal of International Money and Finance, Elsevier, vol. 99(C).
    5. Giovannini, Alessandro & Ioannou, Demosthenes & Stracca, Livio, 2022. "Public and private risk sharing: friends or foes? The interplay between different forms of risk sharing," Occasional Paper Series 295, European Central Bank.
    6. Philip R. Lane, 2015. "Macro-Financial Stability under EMU," Trinity Economics Papers tep0615, Trinity College Dublin, Department of Economics.
    7. Lena Kraus & Jürgen Beier & Bernhard Herz, 2019. "Sudden stops in a currency union – some lessons from the euro area," Scottish Journal of Political Economy, Scottish Economic Society, vol. 66(1), pages 115-138, February.
    8. Philip R. Lane, 2019. "Macrofinancial Stability and the Euro," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(3), pages 424-442, September.
    9. Philip R. Lane, 2019. "Globalisation: A Macro-Financial Perspective," The Economic and Social Review, Economic and Social Studies, vol. 50(2), pages 249-263.
    10. Lane, Philip R., 2016. "Macro-Financial Stability Under EMU," ESRB Working Paper Series 1, European Systemic Risk Board.
    11. Ioannou Demosthenes & Pagliari Maria Sole & Stracca Livio, 2020. "The international dimension of a fragile EMU," Working papers 795, Banque de France.
    12. Timmer , Yannick, 2015. "TARGET2 balances and the adjustment of capital flows in the Euro area," European Economic Letters, European Economics Letters Group, vol. 4(1), pages 15-19.
    13. Philip R. Lane, 2014. "International Financial Flows and the Irish Crisis," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 15(02), pages 14-19, April.
    14. Corbisiero, Giuseppe, 2022. "Bank lending, collateral, and credit traps in a monetary union," European Economic Review, Elsevier, vol. 144(C).
    15. Bettendorf, Timo & Jochem, Axel, 2021. "What drives the German TARGET balances? Evidence from a BVAR approach," Discussion Papers 12/2021, Deutsche Bundesbank.
    16. Ioannou, Demosthenes & Pagliari, Maria Sole & Stracca, Livio, 2024. "The international impact of a fragile EMU," European Economic Review, Elsevier, vol. 161(C).
    17. Scheubel, Beatrice & Herrala, Risto & Stracca, Livio, 2016. "What do we know about the global financial safety net? Data, rationale and possible evolution," VfS Annual Conference 2016 (Augsburg): Demographic Change 145676, Verein für Socialpolitik / German Economic Association.
    18. Stracca, Livio & Scheubel, Beatrice, 2016. "What do we know about the global financial safety net? Rationale, data and possible evolution," Occasional Paper Series 177, European Central Bank.

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    More about this item

    Keywords

    Sudden stops; Target Balances; European Monetary Union;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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