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Modelling the Eurozone as an Extraordinary Exchange Rate Union

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The Trans-European Automated Real-Time Gross settlement Express Transfer system (TARGET) imbalances within the Eurozone can be interpreted as a sign of a missing balance of payments adjustment mechanism for the member countries. As the Eurozone lacks a fiscal union, in theory it is more of an exchange rate union or a system of fixed exchange rates than a monetary union. This paper will show why the TARGET is a crucial indicator for the Eurozone not being a monetary union but instead an exchange rate union, and why countries holding TARGET liabilities against the European System of Central Banks can be compared to a reserve currency country, like the US under the Bretton-Woods System.

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  1. 1.

    A lot of other authors – even in the current literature – get back to these works, too. For a detailed literature overview see e.g. Daseking (1994).

  2. 2.

    A distinction between financial and capital account is not necessary for our model. Therefore, we decided to combine them and only write financial account. The capital account is always included in this term.

  3. 3.

    See e.g. Merler and Pisani-Ferry (2012) or Tornell and Westermann (2012).

  4. 4.

    This can be seen e.g. very clearly in Cour-Thimann (2013), Fig. 13, p. 21.

  5. 5.

    A detailed explanation of the functioning of the TARGET can be found in Sell and Sauer (2011). The resulting base money redistribution is also described in Sell and Sauer (2012).

  6. 6.

    The case of \( 0<{\theta}^i\le {\underset{\bar{\mkern6mu}}{\theta}}^i \) seems to be an unrealistic scenario for GIIPS; that is why we will neglect it in the rest of the paper.

  7. 7.

    Where this particular threshold can be found in reality is still an ongoing debate. To get an idea, one can draw attention to the work of Reinhart and Rogoff (2010). These authors calculated this threshold at a debt-to-GDP level of about 90 %. We are aware of the recent criticism of the Reinhart and Rogoff calculations. Nevertheless, it is indisputable that such a threshold exists; it may be somewhere below or above the famous 90 % level.

  8. 8.

    \( \frac{d{ Y}^1}{d{ G}^1}>0 \); \( \frac{d{ A}^1}{d{ Y}^1}>0 \); \( \frac{ d T}{d{ Y}^1}<0 \); \( \frac{d{ H}^1}{d{ Y}^1}<0 \).

  9. 9.

    Until now, we only consider the trade balances, not the financial account or the TARGET balances. Therefore, country 1’ s balance of payments shows a current account deficit, which leads to a balance of payments in deficit in the short run. For country 2 the situation is reversed.

  10. 10.

    The national income of country 1 is reduced as the declined real exchange rate reduces both trade balances (\( \frac{ d T}{d\frac{1}{k}}>0 \); \( \frac{d{ H}^1}{d{ e}^r}>0 \)) and \( \frac{d{ Y}^1}{ d T}>0 \) as well as \( \frac{d{ Y}^1}{d{ H}^1}>0 \). As explained in footnote 9, current account changes first of all lead to an imbalance of the respective balance of payments. For country 1 we get a deficit. Given the symmetric country structure, the opposite is true for country 2.

  11. 11.

    Until now, we neglect the TARGET.

  12. 12.

    Until now, there exists a demand surplus on the money market of the union. Demand was driven by the higher income in country 1, the higher price levels and the change in θ 1.


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  2. Daseking, C. (1994): Makroökonomische Interdependenzen in einer Wechselkursunion, Europäische Hochschulschriften, Reihe 5, Band 1631, Frankfurt a. M., Berlin, Bern, New York, Paris, Wien: Peter Lang.

  3. De Grauwe, P. (2012): The Eurozone’s Design Failures: can they be corrected?, LSE European Institute inaugural public lecture, November, 28th, http://www2.lse.ac.uk/publicEvents/pdf/2012_MT/20121128-Prof-Grauwe-PPT.pdf, accessed February, 26th, 2013.

  4. Feuerstein, S., & Siebke, J. (1987). Wechselkursunion und Stabilitätspolitik in einem einfachen keynesianischen modell. WISU, 16(12), 635–641.

  5. Kohler, W. (2012): The Eurosystem in Times of Crises: The Greece in the Role of a Reserve Currency Country, CESifo Forum, Vol. 13, Special Issue, January, pp. 14–22.

  6. Levin, J.H. (1983): A Model of Stabilization Policy in a Jointly Floating Currency Area, in: Bhandari, J.S./Bluford, H.P. (Eds.): Economic Interdependence and Flexible Exchange Rates, Cambridge (Massachusetts), London: MIT Press, pp. 329-349.

  7. Mayer, T. (2011): Die verborgene Zahlungsbilanzkrise der Eurozone, EU-Monitor 88, Deutsche Bank Research, November, 8th.

  8. Merler, S., & Pisani-Ferry, J. (2012): Sudden stops in the Euro Area, Bruegel Policy Contribution, Issue 2012/06

  9. Reinhart, C., & Rogoff, K. (2010). Growth in a time of debt. American Economic Review, 100(2), 573–578.

  10. Sauer, B., & Sell, F.L. (2013): Is the Eurozone not a Monetary Union, but an Extraordinary Exchange Rate Union?, Working Papers in Economics, Vol. 25, No. 2, Bundeswehr University Munich

  11. Schlesinger, H. (2012): The Balance of Payments tells us the Truth, CESifo Forum, Vol. 13, Special Issue, January, pp. 11–13.

  12. Sell, F. L. (1998). zu den wirkungen des stabilitätspaktes in der europäischen währungsunion, ifo studien. Zeitschrift für empirische Wirtschaftsforschung, 44(3), 233–266.

  13. Sell, F.L., & Sauer, B. (2011): A Further View on Current Account, Capital Account and Target2Balances: Assessing the Effect on Capital Structure and Economic Welfare, Working Papers in Economics, Vol. 23, No. 2, Bundeswehr University Munich.

  14. Sell, F.L., & Sauer, B. (2012): Money, Capital Markets and Welfare: An Analysis of the Effects of Target2 Balances, CESifo Forum, Vol. 13, Special Issue, January, pp. 55–62.

  15. Sinn, H.-W. (2013): Austerity, Growth and Inflation. Remarks on the Eurozone’s Unresolved Competitiveness Problem, CESifo Working Paper, No. 4086.

  16. Sinn, H.-W., & Wollmershäuser, T. (2012): Target-Salden und die deutsche Kapitalbilanz im Zeichen der europäischen Zahlungsbilanzkrise, ifo Working Papers, No. 149.

  17. Tornell, A., & Westermann, F. (2012): Greece: The sudden stop that wasn’t, CESifo Forum, Vol. 13, Special Issue, January, pp. 102–103.

  18. Vaubel, R. (2012): EZB verstößt gegen Europa–Recht, Handelsblatt, October, 7th.

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The authors would like to thank the participants of the 3rd IWH/INFER Workshop on Applied Economics and Economic Policy 2013 in Halle (Saale), Germany, the participants of the 76th International Atlantic Economic Conference 2013, Philadelphia, PA, USA, and an anonymous reviewer for helpful comments.

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Correspondence to Beate Sauer.

Additional information

The first version of this paper was published as Working Papers in Economics, Bundeswehr University Munich, No. 2/2011 and 2/2013.

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Sauer, B., Sell, F.L. & Werner, T. Modelling the Eurozone as an Extraordinary Exchange Rate Union. Int Adv Econ Res 20, 357–367 (2014). https://doi.org/10.1007/s11294-014-9482-z

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  • Balance of payments adjustment mechanism
  • Debt crisis
  • Eurozone
  • Exchange rate regimes


  • E40
  • E42
  • E43
  • E50
  • E52
  • F34