Kiel Working Papers, Kiel Institute for World Economics
No 1787:
Euro Area: Single Currency - National Money Creation
Stefan Kooths and Björn van Roye
Abstract: The Eurosystem has been pursuing a crisis management
policy for more than four years now. This policy aims primarily at
maintaining financial stability in the euro area by providing vast
liquidity support to commercial banks that are operating in nationally
segmented banking systems. As a side effect, the national central banks
substitute money market operations for cross-border capital flows. The
national central banks are thus increasingly engaging in substantial
balance-of-payments financing, and financial risks are being shifted from
investors to European taxpayers via the Eurosystem. Symptomatically, this
shows up in exploding TARGET2 positions in the national central banks'
balance sheets. The longer this process continues, the stronger the
centrifugal forces become that ultimately might break up the single
currency. Instead of a fiscal union, a euro-area-wide regulatory approach
is required. In addition to establishing a uniform scheme for banking
regulation, supervision and resolution, we recommend that contingent
convertible bonds (CoCos) be introduced to provide a major source of
refinancing for the banking industry. Since CoCos cannot be introduced
overnight, national and European banking resolution funds would be needed
in the short run. These funds would not rescue banks but they would kick in
as soon as a bank's equity is depleted in order to wind up failing banks in
a systemically prudent way
Keywords: Balance-of-payments financing, Target2, Eurosystem, Monetary policy, Financial crisis, Euro area, Financing mechanisms; (follow links to similar papers)
JEL-Codes: E42,; E51,; E58,; F32,; F34; (follow links to similar papers)
47 pages, August 2012
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