8 Responses to The Economics of Target2 balances

  1. Independent of whether Sinn’s current account deficit hypothesis is primary or secondary (from a systematic perspective it is secondary), Buiter’s and Blindseil’s reasoning is misleading. Of course capital inflows – such as those organized through the Eurosystem that give rise to open target2 balances – can fund both current and capital inflows, money is fungible. The question is the relevant counterfactual: what would happen if there was no possibility for the Central Bank of Ireland to run a Target2 deficit? Less bank outflows? Or less Irish spending, giving rise to a more positive current account?

    Obviously the latter. Which means: (on this point), Hans-Werner Sinn is perfectly right. There is no way around it.

    The bug is: correlating target2 balances with bank outflows, as the cited articles do, and then concluding Target2 balances and current accounts are unrelated, confuses correlation with causality.

    All this is of course already explained in my blog post that Storbeck links up.

  2. JKH

    “Target2 does not finance the current account deficits of the PIGS”

    Agreed.

    Target 2 funding for the PIGS IS part of their respective international capital account flows.

    In theory, those capital flows may offset current account flows, to a degree.

    But they may also reflect offset capital account flows, in the reverse direction, to a degree.

    It sounds like it’s as much the latter as the former.

    (A country’s net international investment position is a subset of its gross international investment position.)

  3. Although the debate is meanwhile a little bit boring there’s one interesting thing about it. One side has decided to be in complete denial of reality only for the purpose to score a cheap point: there was and is a “stealth bailout”. Even if the people and the institution itself (ECB) go to great length to explain how the Target2 system actually operates people like Henry Kaspar will say: Nope. Don’t you see the counterfactuals. Of course these counterfactuals are based upon assuming away reality. Which is: there is a common currency and 1 Irish Euro = 1 German Euro.

  4. hkaspar

    @ Stephan

    Of course these counterfactuals are based upon assuming away reality.

    Would you mind elaborating?

    Btw, just for the record: while I consider it correct and appropriate to call the target2 business a “stealth bailout” (of the Irish banking system and its economy), I am also of the opinion that a stealth bailout can be perfectly justified — see point 4 in my blog post (link is at the end of tis comment). Crisis situations are situations in which markets don’t function, thus policy makers have to jump in one way or another with measures to prevent desaster. The ECB’s “stealth bailout” is such a policy measure, and not necessarily a bad one.

    In my view some Sinn critics try too hard to proof him logically wrong on every single point he makes, and debate too little the economic policy merits of his position.

    Regards,
    Henry K

    http://kantooseconomics.com/2011/06/16/wo-hans-werner-sinn-recht-hat-und-wo-nicht/

  5. daniel

    I am with HK on point number 2: The Target 2 balances reflect a phenomenon which has an impact on the net international investment positions of EMU member countries.

    German bank’s have stopped lending to Irish banks on the money market, thus reducing their claims on non-residents. Irish banks have replaced this source of financing by increasing their reliance on central bank liquidity.

    Of course, this is just how a monetary union works. And I don’t understand Sinn’s reference to the United States, where regional offices of central bank should shift some reserves (gold) once a year to re-balance the claims. This sounds to me incompatible with a monetary union. Has anybody a good reference to a paper which explains the system in the US?

    Proposals to limit Target 2 balances implicitly demand to stop granting banks in some countries access to central bank liquidity, which sounds not very reasonable in my view.

  6. Alex

    I agree to daniel’s comment: German bank’s have stopped lending to Irish banks on the money market, thus reducing their claims on non-residents. Irish banks have replaced this source of financing by increasing their reliance on central bank liquidity.

    In my view: It could be argued that as the Target system guarantee Irish banks unlimited credit lines from other Eurosystem central banks it eliminates the sequential-service constraint for German banks. Don’t fearing the consequences of a bank run German banks have a free lunch to repatriate their (Irish) investments. Thus, Sinn should blame German banks not GIPS countries.

    There is a nice piece of research on that topic: http://ssrn.com/abstract=1875565

  7. Mike Maurice

    Karl Whelan wrote: “It’s September 2012 and I’m writing a cheque to a German economics journal to pay my submission fee. However, the cheque bounces. Even though I have sufficient money in my account…In other words, the euros in my bank account can’t do the same things that a euro in a German bank account can do.”

    Karl Whelan got the very basics wrong. He never has “sufficient money in my account”. All Karl has is a CLAIM against his bank for a certain amount of Euros. And it is PERFECTLY NORMAL that his cheque might bounce if his bank cannot fullfill its liabilities towards Karl (in that case because his bank’s claims against the Central Bank of Ireland could not be served).

    Any system which does not feature such cheque bounces is not a market economy system. In a market economy it is Karl’s obligation to thoroughly check whom he lends his money to – that includes banks! People have to be aware that fractional reserve banks DO NOT offer “deposits” in the sense that your money is stored somewhere – instead you as “customer” are in fact nothing else but an investor or creditor to your bank and as such you have to bear the normal market risk that your debtor might become illiquid or insolvent.

    Thus cheques HAVE TO bounce in a market economy – if they don’t, you have some kind of socialist system in which transaction risks are not absorbed by the individual actors but by the collective. In such a system, the existence of private banks and private profits doesn’t make any sense anymore though, as when risks and losses are socialized, profits should be too.

  8. Mike Maurice

    Karl Whelan’s outrage that “the euros in my bank account can’t do the same things that a euro in a German bank account” is misplaced because it rests on the false assumption that he has “Euros” in any account – which is wrong – he only has CLAIMS on Euros (against the bank), and that there are qualitative differences between claims against company A or company B is PERFECTLY NORMAL in any market economy.