The Target2 system, the mechanism by which national central banks in the euro area borrow from or lend to each other, is a good indicator of financial fragmentation along national borders (Figure 4).
A rise in euro-area borrowing costs now looks almost certain following remarks by Jean-Claude Trichet, president of the European Central Bank, on November 18th.
"This should help the rise of the euro as a major reserve currency, enabling the entire euro area to borrow part of the sovereign debt at interest rates comparable to, or hopefully even below, the benchmark German bond".
"It is the first time a euro area bank has borrowed dollars from the ECB since February.
Since 2008, the European Central Bank has been allowing euro area banks to borrow as much as they want at low interest, currently 1.25 percent.
Finally, he examined the spread between euro-area governments' borrowing costs and German government debt, which is considered a safe investment.
In the euro area, that means reducing borrowing costs for firms in the crisis countries of the periphery.Third, and most important, monetary policy does not operate in a vacuum.
If the euro area were able to borrow as a whole, it too should benefit from low borrowing costs, helped by the liquidity advantage of creating what could become a vast government-bond market.But critics of Eurobonds say that creating them within the current framework would actually weaken budgetary discipline, reducing the incentives for weaker states to get their finances in order.
TODAY'S recommended economics writing: Europe's lost Keynesians (Project Syndicate) The banking crisis as a giant carry trade gone wrong (Vox) Don't fear the bubble (Felix Salmon) Foreign borrowing in the euro area periphery (Liberty Street).
But the authors then proceed to offer statistical results in which the majority of their sample consists of euro area countries, which by definition can't borrow in their own currencies — because they no longer have their own currencies.
Christine Lagarde, managing director of the IMF, which cut its growth forecasts for Germany, France and Italy last week, said QE should "help lower borrowing costs across the euro area, raise inflation expectations and reduce the risk of a protracted period of low inflation".
