Thursday, October 1, 2015

Unlimited Targets? Some pointers

By Sergio Cesaratto (Guest Blogger)

In this short note I will not add anything of substantial to the debate with Marc Lavoie on the nature of the Eurozone (EZ) crisis in view of Target 2 (T2). Readers have numerous papers to look at (including Lavoie 2015a/b, Cesaratto 2013, 2015a/b) and posts (Vernengo 2015, Ramanan, 2015). However, although most of relevance has already been said, there is perhaps still some space for few qualifications.

1. Subject of the dispute is on whether the EZ crisis can be considered a balance of payment (BoP) crisis in view of the existence of T2 and of the Eurosystem semi-authomatic refinancing mechanism, or if it should be considered a crisis derived from flawed institutional mechanisms that led, in particular, to a belated intervention by the ECB to sustain peripheral sovereign debts.

Marc believes that given the existence of T2 and refinancing mechanisms, a BoP crisis cannot occur in a monetary union:
“The point that I have tried to make on a number of occasions at conferences is that outflows are not limited by the amount of foreign reserves in the Eurozone context, in contrast to a country on a fixed or managed exchange rate regime. If a Eurozone country is running a current account deficit that banks from other Eurozone members decline to finance, or if it is subjected to capital outflows, then all that happens is that the national central bank of that country will be accumulating TARGET2 debit balances at the ECB. There is no legal limit to these debit balances. The national central bank with the debit balances, which pay interest at the target interest rate, has as a counterpart in its assets the advances that it must make to its national commercial banks at that same target interest rate. And the commercial banks can obtain central bank advances as long as they show proper collateral. Why would the size of current account deficits or TARGET2 debit balances worry speculators?” (Lavoie 2015: 158)
Marc correctly points out the difference in our views:
“Cesaratto (2015°: 151) and I agree when he concludes that “there are no definite limits to T2 imbalances”; he seems to disagree when he adds that “a political limit has been set by the imposition of harsh austerity measures on peripheral countries in order to obtain positive CA balances”. (ibid)
So the difference is that I see policy limits (perhaps political was not the right word) to T2 imbalances in the sense that policy makers cannot see them growing indefinitely, reflecting growing flow and stock foreign indebtedness and, correspondingly, mounting indebtedness of peripheral private and sovereign debts.

2. To give an example, would a central government with a sovereign central bank (CB) let one region (say Calabria) to expand its expenditure issuing regional bonds by letting its CB to guarantee an unlimited issuance? Notably this behaviour would let this region to accumulate an unlimited balance of payment deficit and foreign debt with the rest of the country and the rest of the world. At the minimum the other regions would like to imitate this (electorally) convenient behaviour. The reader can derive by herself the economic consequences of this behaviour.

If this does not complicate the life of readers, a reference to a view that cannot be suspected of fiscal timidity, that is to MMT, is useful here. Wray and Nersisyan (2010: 16) argue that although there are not “financial constraints [to sovereign debt and deficit] inherent in the fiat system”, nonetheless some arbitrary fiscal constraint, e.g. a balanced budget of the cycle, is necessary to avoid that the government “might spend ‘out of control,’ taking too large a percent of the nation’s resources”.

Would any national government let its CB to back a single region to behave this way? And should we expect the EU sustaining a single member, let alone a group of members, to behave this way? Or could we expect the U.S. printing dollars to check the Argentinian foreign debt crisis in 2001?

On a similar vein Ramanan (2015, italics added) pointed out:
“Let’s consider what happens if there is no federal government and if the ECB is the main supranational authority (ignoring other supranational institutions which have limited powers). Suppose the ECB were to guarantee the debt of governments of all Euro Area nations. There’s nothing to prevent, say, the government of Finland to increase the compensation of its employees every year by a huge percentage and thereby affecting Finnish corporations’ compensation of its employees. This will result in a reduction of competitiveness of Finnish producers and Finnish resident economic units will rely more on goods and services produced abroad. This will raise Finland’s net indebtedness to the rest of the Euro Area and the world. If someone believes that this debt is not a problem, how about the inflationary impact of this rise in demand on the rest of the Euro Area?... 
To summarize, the Euro Area problem wouldn’t have been a balance-of-payments problem had the official sector promised to act as a lender of the last resort to national Euro Area governments without any condition. As long as there are conditions, it is a balance-of-payments problem. One cannot pretend that the European Central Bank has or can be given such powers to lend without any condition. And hence the Euro Area crisis is a balance-of-payments problem.”

3. In this sense I do not agree with the ecumenical view taken by Matias Vernengo (2015) according to which:
“Cesaratto and Lavoie hypotheses are one and the same. The balance of payments and the monetary sovereignty views of the European crisis are two sides of the same coin. The fact that overdraft facilities involved in the TARGET2 system could be used to create credit to finance euro imbalances, or that the ECB could buy government bonds in the secondary market does not preclude the fact that the actual crisis is, in the absence of these policies, the result of the inability to manage a CA deficit.”
It can be noted that Matias eventually endorses the argument (that I refrain to attribute to Lavoie but that, perhaps, he might approve) that the absence of an unlimited credit by the ECB is the ultimate cause of the BoP crisis. My view is that it is unthinkable to believe in an open ended support by the ECB (or by the EU governance) of unlimited Target 2 imbalances. And this is, in my view, the ultimate cause of the imposition of austerity policies on the periphery. The ECB “whatever it takes” (threatened) intervention, finalised to alleviate the austerity costs by reassuring financial markets, was indeed subordinate to the adoption of austerity measures - so that no German court could protest, inspired by Werner Sinn, that the ECB was sustaining unlimited peripheral foreign debts.

In Lavoie’s and Paul De Grauwe (e.g. 2013)’s views austerity was functional to reassure the financial markets about the fiscal sustainability of peripheral debts given the absence of the ECB as lender of last resort (see Cesaratto 2015b for a review). Note that this view is exposed to a fiscal interpretation of the crisis (one that Lavoie and De Grauwe firmly oppose). And, indeed, the reader may wander what is the cause of the crisis, given that Lavoie and De Grauwe tend to neglect Robert Frankel’s and others’ story about the similarities of the EZ crisis with the typical financial crisis of emerging economies (see Cesaratto 2015b for a review)

The next are minor points.

4. Marc is correct when he argues that Roberto Frenkel does not reject the “unlimited Target 2 unbalances view”:
“Let me make a final point. Cesaratto (…) enlists Roberto Frenkel (2012) among the
economists who support his ‘balance-of-payments’ interpretation of the crisis. I got quite
a different impression when I read his paper. While Frenkel (2012: 13) agrees with Cesaratto that the adoption of the common currency was a mistake and that the crisis has its origin in ‘the conjunction of fixed exchange rates, full capital mobility and weak financial regulation,’Frenkel nevertheless believes that the size of TARGET2 balances is irrelevant and argues that the sovereign risk premiums observed with GIIPS countries were tied to the absence of a credible lender of last resort”
And indeed in my most recent paper (Cesaratto 2015b) I had already pointed out:
“A more nuanced position is taken by Frenkel (2014, pp. 13-14). On the one hand he regards the eurocrisis as a balance of payment crisis; on the other, he denies that there can be an “exchange rate risk” (the typical manifestation of a balance of payment crisis) in the euro zone presumably because of the combination of Target 2 and the ECB refinancing operations. The increasing sovereign default risk is then attributed to the absence of a lender of last resort. Notably, with OMT the ECB began to act as a lender of last resort but precisely to defuse what Draghi (2012) called in his most famous speech ‘convertibility risk’, that is the risk of a euro break-up.”
5. Finally, although this is less important, I’d like to point out, in Cesaratto (2015a) I was not so pretentious to claim that Lavoie (2015) was entirely devoted to discuss Cesaratto (2013). Unfortunately this is the impression that the reader may get from Lavoie’s incipit of his Reply. When I began my (2015) paper writing:
“In a general appreciation of my work on TARGET2 (T2) (Cesaratto 2013), Marc Lavoie (2015a) criticized my interpretation of the Eurozone (EZ) troubles as a balance of payments crisis”,
by ”general appreciation” I meant “positive reception” (see e.g. the Microsoft Window Word dictionary), but perhaps the way I expressed myself was ambiguous.


Cesaratto, S. 2013. “The Implications of TARGET2 in the European Balance of payments Crisis and Beyond.” European Journal of Economics and Economic Policy: Intervention 10, no. 3: 359–382. link

Cesaratto, S. 2015a. “Balance of Payments or Monetary Sovereignty?. In Search of the EMU’s Original Sin–Comments on Marc Lavoie’s The Eurozone: Similarities to and Differences from Keynes’s Plan.” International Journal of Political Economy 44, no. 2: 142–156. link

Cesaratto, S. 2015b. Alternative Interpretations of a Stateless Currency crisis, Asimmetrie, WP no.8. link

De Grauwe, P. (2013) Design Failures in the Euro zone - can they be fixed? London School of Economics, LEQS Paper No. 57/2013. Link

Frenkel, R. 2012. “What Have the Crises in Emerging Markets and the Euro Zone in Common and what Differentiates Them?”, link

Frenkel, R. (2014) What have the crises in emerging markets and the Euro Zone in common and what differentiates them? in Joseph E. Stiglitz, Daniel Heymann (eds), Life After Debt - The Origins and Resolutions of Debt Crisis, Palgrave Macmillan (quotations from the WP version link)

Lavoie, M. 2015a. “The Eurozone: Similarities to and Differences from Keynes’s Plan.” International Journal of Political Economy 44, no. 1 (Spring): 3–17. link

Lavoie, M. 2015b. “The Eurozone Crisis: A Balance-of-Payments Problem or a Crisis Due to a Flawed Monetary Design?” International Journal of Political Economy 44, no. 2: 157-160. (abstract)

Nersisyan, Y. and Wray, L.R. (2010) Does Excessive Sovereign Debt Really Hurt Growth? A Critique of This Time Is Different, by Reinhart and Rogoff, Levy Institute, WP No. 603

Ramanan (2015) Sergio Cesaratto’s Debate With Marc Lavoie on Whether the Euro Area Crisis Is a Balance-Of-Payments Crisis – II, The Case For Concerted Action

Vernengo, M. (2015) Greece on the verge, Nakedkeynesianism, June 30


  1. New paper by Seccareccia & Correa that touches on the debate: Seccareccia, Mario and Eugenia Correa. 2015. “Supra-National Money and the Euro Crisis: Lessons from Karl Polanyi.” Forum for Social Economics 0(0):1–23.

  2. "To give an example, would a central government with a sovereign central bank (CB) let one region (say Calabria) to expand its expenditure issuing regional bonds by letting its CB to guarantee an unlimited issuance? Notably this behaviour would let this region to accumulate an unlimited balance of payment deficit and foreign debt with the rest of the country and the rest of the world. At the minimum the other regions would like to imitate this (electorally) convenient behaviour. The reader can derive by herself the economic consequences of this behaviour."

    Correct me if I'm wrong but this appears to me to be a straw man of Lavoie's argument. Lavoie is not referring to the financing of expenditures which must be done through the banking system or (as you note) by the central bank. He simply means that the central bank will finance the transfer of a deposit from one bank to another between countries using target2. Unlimited target balances does not mean unlimited lending by the banking system or targeting interest rates on government debt by the central bank. In the United States there are interdistrict settlement accounts that are unlimited but that doesn't mean I can borrow an infinite amount of money in New York and go splurge in california.

    It is notable in this context that the commercial banking system of the Eurozone is, as of November 2014, under supervision of the ECB. It was an important part of the Greek saga when the ECB restricted the amount of Greek bonds the Greek banking system can purchase.

    Additionally, in the run up of the Eurozone crisis with "merely" state level regulation there was enormous cross border lending. Banks sought the high paper returns where ever they could make them. Additionally, there were major cross-border mergers and acquisitions in finance.With the ideology of deregulation in place, it seems misleading to treat spending financed by the Eurozone system as having a national character during this period.

    Clearly then, unlimited target balances is perfectly consistent with regulatory limits on how many expenditures are financed with bank credit and on what terms. Conversely, limiting target balances is perfectly consistent with allowing bank credit financed expenditures explode.

  3. NO, sorry, Lavoie believe in an unlimited lose of reserves by peripheral banks, followed by an unlimitedly replenishment by the ECB. Just read what Ramanan has just written (with a touch of irony):
    "I echo Sergio’s example (on Calabria) with a similar example of my own. If nations in a monetary union cannot face a balance-of-payments crisis, why not have the whole world join the Euro Area and adopt the Euro as their currency and have the ECB as the central bank of the world and guarantee all government debts without any condition? Surely, that should be the solution to the problems of the world! Not! ...The ECB alone cannot resolve the crisis. "
    The full post is in his blog