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

Gabriel Fagan () and Paul McNelis ()

The Institute for International Integration Studies Discussion Paper Series from IIIS

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

Keywords: Sudden stops; Target Balances; European Monetary Union (search for similar items in EconPapers)
JEL-codes: E52 E62 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-ias, nep-mac, nep-mon and nep-opm
Date: 2014-12, Revised 2014-12
References: View references in EconPapers View complete reference list from CitEc
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