European Monetary Unification through Novation. The Political Economy of the TARGET System

When Economic and Monetary Union became effective in January 1999, it remained unclear what accounting treatment to choose for claims and obligations that the Eurosystem’s National Central Banks (NCBs) incur against each other in the ‘Trans-European Automated Real-Time Gross Express Transfer’ (TARGET) system. The Governing Council of the European Central Bank (ECB) decided only later in 1999 that they should be shifted to the ECB as an intermediating balance sheet—a process called ‘novation’. This decision has decisively shaped the countenance of the monetary union and its fate throughout the subsequent two decades but so far escaped the scrutiny of scholarship in International Political Economy (IPE). This paper adopts the perspective of critical macro-finance, which approaches the monetary system as a hierarchical web of interlocking balance sheets, to study the political-economic role of the TARGET system and its successor, the TARGET2 system. We theorize on monetary unification and show that novation of claims and obligations to a third-party balance sheet is not the only possible solution to ‘stitch together’ separate monetary systems at their apex, but likely was the only one politically feasible. Drawing on historical TARGET and TARGET2 data, we explain how the novation method at the top of the hierarchy has repeatedly served to defend the integrity of the monetary union, both monetarily and politically. It has also enabled the evolution of the ECB balance sheet as an idiosyncratic tool that the Eurosystem could use to tackle multiple problems, in particular setting up swap lines and introducing unconventional monetary policy.