The Bundesbank and Target2 – the about-face that wasn't

It appeared like a stunning about-face. Earlier this month, press reports suggested that Bundesbank president Jens Weidmann was deeply worried about the imbalances in the Target2 payment system of the Euro area.

According to these reports, in a letter to Mario Draghi Weidmann urged the ECB to beef up the Target2 liabilities of countries like Greece, Ireland, Spain and Portugal with additional collateral.

“Euro Intelligence” even claimed that Weidmann labeled the Target2 imbalances as a “major concern”. The website also suggested that the Bundesbank has taken up proposals initially made by Hans-Werner Sinn to fix the imbalances in the Target2 system. (Sinn himself shares this impression.)

If all this really was true, it would be a complete U-turn by the Bundesbank. For one year, the German central bank has been arguing that Target2 liabilities do not constitute any additional risks neither for the German central bank nor the Euro system. For example, in February 20111 a press release asserted:

“The size and distribution of the Target2 balances across the Eurosystem central banks are, however, irrelevant to their risk exposure from the provision of funds by the Eurosystem: Target2 balances do not pose specific risks to individual central banks.”

As the Bundesbank pointed out in these days, Target2 balances do

“not create any new specific risk not already contained in monetary policy refinancing operations”.

Similar statements were made in Bundesbank’s March 2011 monthly bulletin as well as in a piece by Bundesbank staff published in the CESifo bulletin. (Note that the ECB made similar points in its October 2011 monthly bulletin and that the former chief economist, Jürgen Stark, strongly opposed the claims of Hans-Werner Sinn.)

If Weidmann now really considered the Target2 claims by the Bundesbank as a “major concern”, this would undermine the credibility of the German central bank.

It would either imply that the central bank tried to hoodwink the public into thinking that the Target2 imbalances were harmless while they were in fact risky.

An alternative explanation, put forward by Karl Whelan, is that Weidmann was just talking rubbish. As Karl puts it:

“I suspect most of us have worked for bosses that say things in public that are just plain wrong and I would guess that the sober Bundesbank officials that approved of the monthly bulletin piece on Target2 are fairly disgusted that Weidmann is adopting an approach in public that they know is ungrounded.”

Well, there is a third possible explanation which – from my point of view – is the most likely one. It’s just a misunderstanding. Almost nobody who publicly talks about the Weidmann letter has ever seen it.

Even “Frankfurter Allgemeine Zeitung”, the newspaper which broke the story about Weidmann’s letter to Draghi, did not give a single verbal quote.

In background conversations, sources close to the matter pointed out to me that the Bundesbank by no means changed their mind about the Target2 balances. They are still concerned about the additional risks taken up by the loose collateral requirements, not by the Target2 balances in themselves.

My colleague Mark Schieritz, Frankfurt correspondent with the German weekly “Die Zeit”, apparently also had a glance at the letter. In last week’s edition of “Die Zeit”, he also suggested that the Target2 views of the Bundesbank were misrepresented. According to Mark, Weidmann’s letter pointed out

 ”that the Bundesbank also is sceptical with regards to caps on Target2 balances. Weidmann asserts that the risks on the ECB’s balance sheet are caused by the fact that the central bank provides a lot of liquidity. This liquidity is distributed unevenly in the Euro area.

However, Weidmann solely urged to “further analyse” if the risks could be mitigated by tweaking the Target system, for example through the pawning or transfer of assets to the ECB.

However, according to Weidmann, it would make more sense to originate less risky credit in the first place. “Decisions by the government council must not perpetuate the situation of mounting risks,” asserts Weidmann.”

An op-ed piece written by Jens Weidmann in Tuesday’s edition of “Frankfurter Allgemeine Zeitung” confirms the impression that the general stance of the Bundesbank towards Target2 did not change at all.

In this piece, made available in English today by the Bundesbank, Weidmann did not ask for any “pawning” of collateral. He did not urge for the transfer of assets to the ECB either. Instead, he asserted:

“If euro-area monetary policy were centralised at the ECB, there would not be any Target2 balances; however, this would not inherently alter the risks associated with providing liquidity. (…)

Weidmann stresses that he does not share the criticism with regards to Target2:

“An increase in Target2 balances may thus mirror a bona fide monetary policy response to a looming liquidity crisis within the bounds of its mandate. To that extent – as the Bundesbank has repeatedly pointed out – criticism of the Target2 balances per se is misplaced.

As I see it, the Bundesbank’s Target2 claims do not constitute a risk in themselves because I believe the idea that monetary union may fall apart is quite absurd. Whether and to what extent losses arising from liquidity provision actually impinge on the Bundesbank’s balance sheet does not depend on the volume of the Bundesbank’s Target2 claims. This is also true for the hypothetical scenario, which has sparked much public debate, of a member state with a negative Target2 balance potentially exiting monetary union.

Even in such a case – which I consider to be highly unlikely – the risk remains rooted in the nature and volume of the liquidity provision. This might result in partial defaults on the ECB’s claims. However, any losses sustained by the ECB would have to be borne jointly by all Eurosystem central banks, irrespective of the size of their Target2 balance.”

As Weidmann points out, the debate should focus on the quality of the collateral used in the refinancing operations, not on the Target2 balances:

“In the Eurosystem, however, there is broad agreement that the non-standard monetary policy measures are limited and temporary, and that they may on no account be used as a pretext to postpone necessary financial and economic policy reforms. It is an uppermost concern of mine to ensure that this does not give rise to any stability risks, such as would be the case if the public were to believe that monetary policy were being held hostage by fiscal policy.”

The bottom line is that the Bundesbank in fact did not change its general perception about the Target2 imbalances and they do not subscribe to the views of the usual Target2 critics.

This seems to be a severe misinterpretation of the Bundesbank’s view, probably fostered by some interested parties in the debate.


Filed under Monetary Policy, Target 2

5 Responses to The Bundesbank and Target2 – the about-face that wasn't

  1. Sebastian Paul

    well “Euro Intelligence”/W.Munchau did “effective” journalism, just repeat for months what you believe until the right letter comes around the corner…

  2. Sebastian

    So I might not understand this very well but it could be that although these balances cancel out, they still are pretty risky. Again, I am not sure but as far as I know, the Bank of Greece is (at least in money terms) a subsidiary of the Greek state. I also think i) the currency issued by BoG is more than what it is allocated to them by the ECB; ii) and that only an amount of notes equivalent to their yearly allocation has serial numbers that identify that currency as Greek; and so iii) it follows that the Bank of Greece regularly prints euro notes that are indistinguishable than those printed by say Finland. If I was an entrepreneurial Greek politician who decided that it is time to go off the Euro and I win an election and somehow manage to pull off an Argentinian style corralito and turn everyone’s deposits into Dracmas… why would I ever send the euro notes in the BoG’s vault back to the ECB? Given those euros would still be good to buy German-made cars, why wouldn’t I use that money to buy every Greek person half a BMW? In short, if Greece were to leave the Euro, how could the BoG ever be compelled to settle its balance with the ECB? If i am fully wrong, please teach me bc I am sure I am overlooking something. Thanks!

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  4. bena gyerek

    whatever weidmann says in public, he damn well should be concerned about the imbalances, particularly to the extent that they are financing capital flight from the piigs. so far, the imbalances mostly represent the transfer of existing interbank loans onto the eurosystem’s balance sheet. the problem is when piigs nationals start moving their cash to the safety of a german bank account. the bundesbank could find itself financing a run on the piigs banking systems in the run-up to euro exit. the other thing that would worry me is how it will play on the front page of bild if greece leaves the euro and defaults on its target2 claims. won’t bild ask why on earth the ecb is providing even bigger loans to the italian and spanish central banks?

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