Abstract

While the formal decision of the ECB Council to impose interest on Target claims and liabilities is meaningless, this paper shows that the pooling of primary interest income among national central banks in the Eurozone implies that Target and cash balances do, in fact, bear an effective rate of interest. The magnitude of this effective rate of interest is given by a weighted average of the ECB’s policy interest rates where (i) the relative country sizes and (ii) the uses of alternative sources and sinks of international liquidity flows determine the weights. Without countervailing transactions, which would effectively service the Target claims and liabilities, Target balances grow with compound interest. The payment of interest on Target balances internalizes the competitive externality that otherwise could induce excessive money supply in a decentralized monetary system of the kind characterizing the Eurozone. It also implies that the recording of Target balances in the balance sheets of national central banks is compatible with fair value accounting.

Highlights

The Eurozone’s Target and cash balances carry an effective rate of interest. • The effective rate of interest is a weighted average of the ECB’s policy rates. • Target balances grow with compound interest. • Aizenman’s competitive seignorage externality is absent in the Eurozone. • Target balances are recorded in line with fair value accounting.

JEL-Codes:

E400, F410, F450, H600.

Keywords:

Target2, ECB, interest, competitive seignorage externality

Paper available at www.cesifo.org