Forging monetary unification through novation: the TARGET system and the politics of central banking in Europe

Abstract

When the European Monetary Union became effective in January 1999, the accounting treatment for claims and obligations which the Eurosystem’s National Central Banks (NCBs) incur against each other in the ‘Trans-European Automated Real-Time Gross Express Transfer’ (TARGET) system remained unspecified. Only later in 1999, the Governing Council of the European Central Bank (ECB) decided that these claims and obligations should be shifted to the ECB’s balance sheet as a central counterparty—a process called ‘novation’. This ex-post decision completed monetary unification by uniquely ‘stitching together’ NCBs’ balance sheets while profoundly transforming the role of the ECB’s balance sheet. First, novation centralised it at the Eurosystem’s apex, which had not been politically feasible ex ante. Secondly, novation repurposed it into a multilateral mechanism to provide automatic, unlimited funding for cross-border payment imbalances. Thirdly, novation allowed monetary technocrats to operationalise it as an autonomous ‘firefighting’ balance sheet for unconventional monetary policy.

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“…If any surpluses or deficits remain at the end of each business day after clearing, the NCBs shift their claims and liabilities to the ECB balance sheet in a process called 'novation'. This provides an unlimited funding mechanism for crossborder imbalances which is integral to maintain monetary union (Bindseil and König 2012) and makes the ECB the hierarchically highest balance sheet in the Eurosystem which thus functions as a central counterparty (CCP) to all other NCB balance sheets (Murau and Giordano 2023).…”

“…Despite this, European treasuries expanded their balance sheets (manifested in increased sovereign debt levels) as they had bailed out failing banks in the GFC and the Eurocrisis and backstopped the real economy in the COVID-19 crisis (Tooze 2018;. At the same time, central bank balance sheets expanded massively as well-for instance, via TARGET2 imbalances, asset purchase programmes, and tweaks in the collateral framework (Murau and Giordano 2023;van 't Klooster 2023). Nevertheless, treasury and central bank balance sheets in the present European monetary architecture are strongly biased towards 'reactively' expanding ex post while it is politically, legally, and administratively difficult to make them 'proactively' expand ex ante as it would be required for a green initial expansion.…”

“…In the Eurozone 2.0, the ECB balance sheet was operationalised for active firefighting purposes as its elasticity space was increasingly harnessed for the purpose of asset purchases. The latest example is the Pandemic Emergency Purchase Programme, which was the Eurosystem's core response to the COVID-19 crisis and heralded the start of the Eurozone 3.0 (Murau and Giordano 2023). Therefore, the European monetary architecture has now developed ample elasticity space to support liquidity insurance.…”