Target2 debate – The ECB finally gets involved

Several months ago, German economist Hans-Werner Sinn stirred a debate about an alleged “stealth bailout” happening in the Eurozone. According to Sinn, the Bundesbank and other central banks in the core of the Euro area secretly give loans to the countries in the periphery that come at the expense of their own banks.  A number of economists and journalists (including me) have contradicted Sinns arguments.

Now, finally, the ECB itself gets involved. In its latest monthly bulletin, published yesterday, the central bank addresses the arguments of Hans-Werner Sinn. From my point of view, this analysis is at odds with Sinn’s view.

Here’s a table that compares of statements by Sinn and the ECB on the matter.

At the core of the debate is the electronic payment system that private banks use to settle cross border payments in the Euro area. This system is called Target2. (A detailed description of the system and the debate is available here and here.)

Here’s a brief summary of the key points from the ECB monthly bulletin:

- Sinn suggests that the Target2 operations come “at the expense of German banks”. The ECB, however, points out:

“It would be wrong to believe that TARGET2 liabilities that result from the provision of relatively large amounts of liquidity to banks in some countries have a negative impact on bank lending in other countries.”

- Sinn’s asserts that current design of the cross border payment system is flawed and detrimental to the stability of the Eurozone. He writes: ” It (…)  leads to hefty foreign debts and undermines the ability of the ECB to influence with its interest-rate policy the economies of the countries where the surplus money is flowing to.” This is the view of the ECB:

“The distribution of liquidity within the Eurosystem provides stability, as it allows financially sound banks – even those in countries under financial stress – to cover their liquidity needs, thereby contributing to the effective transmission of the ECB’s interest rate decisions to the wider euro area economy, with a view to maintaining price stability in the euro area over the medium term. “

- Sinn suggests that there should be an upper limit on  Target2 balances. The ECB asserts:

“As there can be no upper limit on the value of payment flows within a single currency area, there can be no upper limit on the TARGET2 balances of NCBs. Limiting the size of TARGET2 balances would be inconsistent with the concept of a currency union. “

- Sinn claims that similar imbalances cannot occur in the United States because the electronic payment system is designed differently.  The ECB, however, writes:

“[I]n the United States, there are no limits on payment flows within the currency area formed by the 12 Federal Reserve districts. Interdistrict balances emerge from such payment flows, which are not more constraining than the TARGET2 balances are in the Eurosystem. The mechanism used in the United States to readjust interdistrict balances once a year has no influence on cross-border payment flows and essentially leads to the adjustment of the key used for the allocation of profits and losses of the US Federal Reserve System to the 12 district Reserve Banks”

Interestingly, however, the Ifo institute published a German  press release earlier today asserting that there are “no factual differences” between Sinn’s view and the points made in the ECB’s monthly bulletin.





Filed under Financial Crisis, Monetary Policy, Target 2

6 Responses to Target2 debate – The ECB finally gets involved

  1. ….and misses the point. Like the unifying european institution it is, the ECB attempts to maintain the party line that EMU is like the Federal Reserve System. It is not. That is because after repeatedly compromising its collateral standards, the ECB is now effectively providing central bank money at cut-price rates to the least creditworthy countries. That may have stabilised the european money market during the present crisis, because it is part of the bailout mechanism, but it is not a normal function of a seamless monetary union. What the ECB needs to tell us if they want to put this to bed is something about the breakdown of refi collateral by country, and the haircut applied. If the loans to the GIPS banks are as solidly collateralised as they would have been before the crisis, EMU really is like the Federal Reserve System and Sinn is wrong. I would be surprised if that was the case.

    As usual, I refer to my blogpost which analyses this issue from first principles:

    It might not be an easy read, but if you are not prepared to put in a bit of effort to understand, your opinion is worthless.

  2. Note that a corollary of the mechanism for inter-district fund transfers is that, providing a country can come up with enough acceptable collateral to keep borrowing from the ECB, as far as I can see there is no connection between default and membership of the euro. Merkel and Sarkozy’s threat to Greece about the Greeks having to leave the euro if they reject the bailout terms is either hollow or deliberately vindictive. In principle there is nothing to stop Greece remaining in the euro even if it defaults on its public debt.

  3. to cut it very short:
    target2:=bilanzverlängerung:=aufblähung der geldmenge…

  4. scott putnam

    Even if the German banks are flush with deposits today and changing the balance at TARGET2, the fact remains that BundBank has an outstanding liability of 500 million euros. When Greece and other southern nations are forced out of Euro, they will have to recognize that liability as a loss. The BundBank is not managing their cash flow credit risk (account receivable vs accounts payable) like a sensible corporation does. The risk to Germany is huge/.

  5. That’s a question. If Greece were asked to leave the EZ, the Greek central bank would still have the target2 liability. On what terms would that liability be reconstructed in the substitute currency? Greece would in effect cease to be able to import from the EU because transfers would just go into the target2 debt, which would also be dramatically larger as the substitute currency devalues. Essentially, no Greek exit is feasible. What the EU wants, I presume, is reform in Greece, and perhaps a little revenge for having been ripped off by those who cooked the Greek books. Obviously, Greece is well and truly gripped by the balls.

  6. Pingback: The Bundesbank and Target2 – the about-face that wasn’t | Economics Intelligence