Are TARGET2 imbalances remunerated? The hidden mechanisms of Eurosystem monetary income

This paper addresses the vexed question of whether Eurosystem National Central Banks (NCBs) pay interest on their respective TARGET2 (T2) liabilities by considering the process through which all NCBs pool and are subsequently allocated an amount of "monetary income". The paper argues that NCBs with T2 liabilities do pay, but in disguised ways that are only fully revealed by unpacking the monetary income pooling/allocation process. To show how this is the case both in theory and in practice, we detail two specific mechanisms that are saddled within the monetary income pooling and allocation process-denoted as a "restitution mechanism" and a "compensation mechanism". The paper also exhibits how certain factors can influence the extent to which NCBs with T2 claims are renumerated.