Today’s FT Alphaville carries another story by Izabella Kaminska on why the Bundesbank’s Target credit and its low level of
private securities owned, em, loans to German banks may be a source of problems.
Thankfully, the Bundesbank flogging off the
family silver, em, gold, has disappeared from sight. This time, Izabella cites two potential problems. Taking them out of turn, there’s the argument of Perry Merhling on factors affecting the “collateral crunch” in the banking system:
A second source of demand for collateral is the discount lending by national central banks to their own private bank clients. And a third source is the Eurosystem lending between national central banks, which takes place more or less automatically through the operation of the TARGET2 payments system.
Except that the TARGET2 credits and liabilities don’t involve the use of any collateral, so this is not, in fact, a source of collateral crunch.
Izabella’s other mechanism for concern isn’t accurate either but does have a bit more plausibility about it. She notes about the process of deposits flowing to Germany that
every time the German Bundesbank attracts commercial liabilities (deposits) via this process, in an ideal world it would want to sterilise them to keep its bond market in check with ECB policy.
In order to do that, it would be inclined either to offer domestic assets into the market outright or unwind the number of bank loans it has extended against domestic collateral
In other words, Izabella reckons that to implement ECB policy on interest rates, the Bundesbank needs to control the money supply in Germany. If this was true, and the Bundesbank had no loans to German banks, then it couldn’t cut back on these loans as a way to control this supply of money and thus influence interest rates.
This is an interesting idea but it’s also pretty far from an accurate description of how European monetary policy works. A couple of points.
First, you’ll be very hard pressed to find a real-world central banker familiar with operational issues who believes that the short-term money market rates targeted by central banks depend in some predictable way on controlling some definition of the money supply. Here and here are two good papers that discuss this issue in detail. And here and here are my own teaching notes where I discuss these issues.
To summarise, the ECB influences money market rates in the Euro area via a “corridor system” determined by the interest rates on its range of instruments (deposit facility, marginal lending facility and refinancing operations) rather than via the quantity of money supplied.
Second, in an “ideal world” (i.e. a fully functioning monetary union) the supply of money in Germany should have no influence whatsoever on the rates at which German banks borrow from each other. A bank can borrow funds from any other bank in the Euro area or directly from the ECB. Even in the ideal world that preceded the crisis, the Bundesbank wasn’t attempting to hit some target for the German money supply, so there’s no loss of control for the Eurosystem relative to what prevailed before and no loss of control over price stability.
Now, of course, the absence of an ideal world means that all sorts of other complications are affecting European money markets. The super-low rates that Izabella notes here are likely related to factors such as fears about the end of the Eurozone and the drastic reduction in the amount of assets viewed as truly safe. They’re not due to the Bundesbank losing the ability (which it wasn’t using anyway) to control the German money supply.