Interpreting TARGET2 balances

A new BIS paper on this topic is available here.

42 replies on “Interpreting TARGET2 balances”

Angela is very pleased.

The scale of it for a small country is well…… the scale.

The more time we give the more damage to our now absurd domestic economy.

There will come a point where redenomination is no longer a rational option , more like a pointless option as there will be nothing remaining that can be saved.
Everything both human & physical will have been depreciated into dust.

A word beginning with T comes to mind and its not Target 2


DeGrauwe, P and Y Ji (2012): “What Germany should fear most is its own fear”, VoxEU, 18 September

+The Jolly Professor

Yet another paper by academic types discussing TARGET2 long after the blogosphere reached its conclusions, tilting at the out of date argument that the TARGET2 balances reflect current account balances and referring to papers by other academic types as if they were the only ones who had anything worthwhile to say on the subject. The bottom line is that Sinn’s claim that the Bundesbank’s TARGET2 credit represents a significant risk to German wealth remains intact, and everyone that tries to prove otherwise gets dismantled until they withdraw from the debate rather than admit they are wrong – latest installment here:

@ RebelEconomist

thanks for the link to Karl’s always excellent posts. He puts Sinn’s dangerous and divisive theory rightly to the sword.


I am afraid that he does not! The one point of agreement is seemingly that whatever happens will only happen in the event of the euro breaking up. I suggest that nobody knows the answer but it certainly will not be to Germany’s advantage.

RebelEconomist, and Professor Sinn, are, to this extent, right IMHO. cf this comment from the former in the blog posts replying to Karl Whelan.

“Either we are being asked to believe that a new deutschmark would be a significantly more international currency than the US dollar, or Karl is double-counting the seigniorage offset to Germany’s TARGET2 exposure.”

Many aspects of the technical arguments advanced by KW are not easily compreheneded by anyone not expert in the technical substance but the point made by RebelEconomist suggests that any broader conclusions drawn from them by him should be treated with caution.

RebelEconomist: “…everyone that tries to prove otherwise gets dismantled until they withdraw from the debate….”

Remarks like that always summon to my mind the image of an old man in a park shaking his stick and yelling: “Come back Sir! I haven’t finished yet!”

It was RebelEconomist who told us that a choice not to maintain the solvency of a central bank is tantamount to a lack of commitment to its inflation target. I’m still waiting for an argument in support of that extraordinary claim.

@docm, Eoin

I think Karl initially gave many people / many people got the impression that he was arguing the Germans would not suffer a meaningful loss of wealth that anyone should be bothered about by replacing their Eurosystem claims with an A4 sheet of paper. Mutual wind-up session linked below:

“Fine, write off the €500 billion and call it a hit the German IIP position if you want. All this entry corresponds to is a claim on a central bank which can print money. I’ve pointed out that the new Buba can write out a new piece of paper that’s worth the same amount, add interest to it every year, and keep it in a vault somewhere. This exactly offsets any perceived loss.

I think what people are missing here is that central bank assets are not a good way to think about the wealth of a nation.

A central bank can have as many assets as it wants by printing money and acquiring them. And it can send the revenues from these assets back to the fiscal authority if it wants. However to do so in a big way tends to lead to inflation.

In this example, the central bank loses one asset and replaces it with a piece of paper with a face value and interest pattern that mimics the original asset. No loss in wealth for the Bundesbank and no new money circulating in the private sector (deposits have not changed) so no inflation either.”

“The target 2 credit is not foreign-currency denominated assets. It does not play the same role as the large accumulation of foreign assets that some Asian central banks have run up. Replacement of one domestic currency asset (the euro asset that is the Target 2 credit) with another (the D-mark check in the magic vault after euro breakup) will keep things exactly as they were before and won’t affect Germany’s holdings of foreign-currency denominated assets.

But look, you guys can believe what you want. Hopefully, the breakup thing will never happen, so this turns out to be irrelevant.


PDeG states “We have to slow down with austerity or we will create a deflationery spiral.The recent decision by the ECB to become a lender of last resort is a key regime change. We have to send signals that the eurozone is here to stay. We need a fiscal union -a banking union implies a fiscal union. We need a political union.

The euro is a currency without a country. To keep the euro we have to create a country-If we say we don’t want to create a european country then we have to say goodbye euro.”

It’s not that hard, Kev. If the central bank has negative net worth, there is a limit to the amount of assets it can sell to absorb its base money, so such a central bank runs the risk that it reaches a point at which it can no longer defend its inflation target using its own resources. I am sure I made that argument before.

Yes, Grumpy, that discussion thread was a classic example. As the points that Karl and his supporters raise get answered (eg TARGET2 credit bears interest paid from outside Germany; the fact that TARGET2 credit is denominated in euros does not mean that it is not part of Germany’s national wealth) and Karl runs out of places to hide, he starts complaining that his opponents are wasting his time. On that occasion, I think he even disabled further comments.

Fundamentally, I think the origin of the difference between Karl, Paul De Grauwe, Buiter etc and Sinn or myself is that the former see a central bank as a bottomless slush bucket of seigniorage which can wash away problems, whereas I see a central bank, except in times of national emergency such as war or bankruptcy, as a not necessarily public business which provides medium of account services, which can supply no more than its customers demand and must try to honour its guarantees for the performance of its medium of exchange. Karl thinks he understands central banking because he used to be a central bank economist; I think I understand central banking because I used to work in central bank market operations. Take your pick, but at the end of the day, it is the Germans’ opinion as chief eurozone paymasters which really matters.

“I am sure I made that argument before.”

If you click on the link I provided you’ll see the arguments you made, e.g.:

If the real value of its money is falling at an unacceptable rate (ie it looks like the CB’s inflation target will be breached), the cb can buy some of its money back to raise its value. In order to do so, the cb must have assets to sell. To be able to keep its promise come hell or high water, the cb must ultimately have assets at least as valuable as its liabilities – ie the cb must be solvent.

As I explained:

The third sentence does not follow from the previous two. A central bank can pay a sky-high rate on deposits and charge an even higher rate to borrowers. The quality of its assets has nothing to do with this. If a commercial bank is forced to turn to the central bank as LOLR, it makes no difference whether the central bank holds more gold than Fort Knox or just a small tin of sardines.

Ah yes, I remember that debate now, Kev…….we were eventually invited to have it somewhere else!

I think your argument usually works, but cannot be guaranteed to work in general, which is why central banks aim to be solvent (I appreciate that some have operated for long periods while insolvent such as in the Czech Republic and Chile). If you think about it, the central bank can only raise interest rates in the process of expanding its balance sheet. For this, either the demand for money needs to be rising or the central bank balance sheet needs to have been allowed to shrink as its short-term loan assets mature (and the sub-section of the balance sheet that shrank was solvent). Solvency would only matter if it became necessary to shrink the central bank balance sheet a lot. You are right that moderate insolvency need not prevent the central bank tightening in most plausible situations, but, as you know, central banks are conservative institutions!

@John Corcoran

I remain a committed European Integrationist …. but also exploring other scenarios due to the abysmal nature of EU leadership and its flawed ideology.

In an inexact discipline such as financial economics I tend to make qualified decisions based on my reading of the reputation and competence of the writer/academic/commenter: in this case I see no contest between De Grauwe and Sinn – the former is quite simply far superior. I also have more than a little time for the Jolly Professor in this area ….

as for DOCM and TheRebelEconomist in the anonymous lower divisions I have insufficient information on the latter while noting that my views on DOCM’s financial sector bias and spin are shurely well known … ergo I abstain on this one while reading and noting both.

If raising interest rates cannot be guaranteed to curb inflation in general, you should be able to come up with a case in which it fails. Then the discussion might get somewhere. Model, please?

Its pretty clear now central banks don’t print the money

The experience of the BoE and the run on it in 1914 is the classic case.

HMT printed the money (but it was debt also )

It was the birth of Keynesian thinking was it not ?

OK, Kev. A central bank which supplies and backs most of its base money with government bond purchases, like the Fed or the BoJ, which happen to have fallen in market value since purchase. Demand for currency drops, say because of the introduction of some new retail payment technology like stored value cards. If currency demand drops enough, the central bank runs out of assets to sell to absorb the excess base money. The central bank can offer interest bearing deposits to lower the velocity of its money, but since it is paying the interest in base money, that just kicks the can down the road.

Fine, so it kicks the can down the road. If inflation is 10% and the central bank thinks that’s too high, it pays, say, 20% on deposits. It’s unlikely that any other borrower can compete with that. But if they are so foolish as to try, the central bank bids the rate up to 30%. Sooner or later the market will crack and the demand for goods will be choked off. The Volcker method of halting inflation doesn’t require central bank solvency.

Right. So after, say, a year in which they have successfully forestalled inflation, the central bank has 130% of its original stock of base money outstanding, and still a shortfall of demand for base money even below the initial 100%. They have come to the can again, and now it is bigger.

It doesn’t make a lot of sense to talk of a shortfall of demand for money when excess demand for goods is choked off by high real interest rates. I suppose what you mean is that the required (nominal and real) interest rate could be rising. That’s possible, but it’s not something that can continue indefinitely. For one thing, the real money stock M/P can’t exceed 100% of total real wealth. It can’t even equal 100%, but what the actual upper limit is, doesn’t greatly matter. What matters is that there is an upper bound; so even if the sequence M(t)/P(t) is increasing it has to converge.

Forget the effect of interest rates on demand, Kev, that is just part of the transmission mechanism. Think like a monetarist. The point is that for some reason there is more base money than demanded at current prices. If the central bank has insufficient assets to sell to absorb the excess money, the only way that it has of increasing demand for that money is to pay out more base money, digging the hole a bit deeper. I suppose that the central bank might be able to increase reserve requirements if they have the vires, but then you can ban price rises altogether Diocletian-style if you have the vires!

But hey, all this gets a bit far off the point, which is that the Bundesbank’s TARGET2 loss would make the Bundesbank insolvent (agreed?), and it is not me but the Germans that you need to persuade that they need not worry if the Bundesbank is insolvent – glück mit dass!

See, it makes no sense at all to me when you say there is more base money than demanded at current prices. It can of course make sense to say there is more scrap iron, or more tinned grapefruit, than demanded at current prices. These things are then piling up in inventories. But money? There’s no way people can be holding money they don’t want to hold. That’s what makes it money; it’s liquid. If, at current prices, you’d prefer to hold something else, you can always make the exchange.

Nick Rowe hammers away at that point ad nauseam so it’s a bit odd that you ask me to think like a monetarist. That’s just what you are not doing.

I’m sure Hans-Werner Sinn would love a world in which the Germany could seize the Parthenon in order to restore Bundesbank solvency. But that’s no reason to claim it actually needs to be solvent to control inflation. AFAIK you’re the only one making that particular claim, though I don’t doubt there are others out there.

“There’s no way people can be holding money they don’t want to hold…..If, at current prices, you’d prefer to hold something else, you can always make the exchange.” That’s the point; in an attempt to get rid of their excess money, individuals offer more of it in exchange for other items – ie they drive up prices. In other words, what Nick Rowe would call the “hot potato” effect. People can’t collectively get rid of base money of course, but they bid up prices until the nominal stock of money is willingly held, because the real stock is smaller.

I think my view is quite conventional. Peter Stella at the IMF has written about central bank solvency eg here:

In its 2010 convergence report, section, the ECB criticised the Czech Republic for the negative capital position of its central bank, here:

I agree, and paying the interest involves expanding the base money supply, so it only forestalls the problem of excess base money.

Perhaps you are overlooking how a central bank raises interest rates. Normally, it would do so by a contraction (actually an incipient contraction is usually enough) of the base money supply, typically engineered by not rolling over some of its assets, or if necessary selling some. But that is the problem – by definition, when the central bank is insolvent, at some point it will run out of assets to sell, so instead it must pay interest on base money.

“…only forestalls the problem of excess base money.”

Again, there cannot be an ‘excess’ of money in a market economy. It’s only possible in situations such as wartime rationing, where just having cash isn’t enough, you have to produce coupons. That’s not relevant here.

If nominal interest rates are high enough, inflation will be curbed. If the monetary base is expanded in the process that won’t deter a determined central banker.

Yes there can be an excess of money, at existing prices, if there is a negative shock to base money demand (the example I gave was a change in retail payment technology, but I guess your example of reduced wartime retail supply will do as well). A market economy would then respond by raising the prices, which the central bank has promised to prevent.

You keep repeating the point you make in your second paragraph, but I am not disputing it. I just say that raising interest rates in the only way available to a central bank with no assets left to sell puts the central bank on a treadmill. Do you disagree?

These do not have to be likely scenarios; just ones which the central bank wants to have the capacity to deal with.

You expect the Germans to be assured by the argument that their central bank needs no assets to control inflation because it can sustain high interest rates indefinitely as real money stock approaches 100% of real wealth asymptotically?

Your claim that an insolvent central bank can’t meet its inflation target is false. That’s all I’m saying. As to what Germans may or may not find reassuring, I’ll leave that topic to others.

False in a theoretical world in which the central bank can expand base money supply for ever to restrain inflation, perhaps; not in general, and certainly not in any realistic model.

No central bank should have a problem with expanding base money supply forever. Lots of economic variables rise over time. It’s not frightening, particularly if the growth-rate slows, as it will when the policy bites. As for models, I asked you for one way upthread. You didn’t respond to that. I doubt that you have one. As for realism, I don’t know of any case in history where a high interest rate policy has failed to curb inflation. Central bank solvency has nothing at all to do with that.

“I don’t know of any case in history where a high interest rate policy has failed to curb inflation”. Of course; any policy which contracts base money supply will be associated with higher interest rates than otherwise, whether the policy is specified in terms of interest rates or something else, like balance sheet quantities. The question is how those higher interest rates come about, and whether they are sustainable.

I regard what I gave you as a model of Krugman’s third type here:

That is more than you are giving me. I am not entirely sure how operationally you think that the central bank can produce higher interest rates when it reaches the point that it has only liabilities left on its balance sheet.

RebelEconomist: I regard what I gave you as a model of Krugman’s third type here:

[Krugman:] Some readers asked, what do I mean by a “model”? The answer is, I’m pretty generous on that front – it could be solved equations, it could be a computer simulation, it could be a physical apparatus like the Phillips hydraulic Keynesian model, or it could just be a carefully written verbal discussion like Hume’s essay on the balance of trade. What makes it a model is that however it’s presented, it involves a careful discussion of micromotives and macrobehavior – that is, it describes what individuals are doing (not necessarily out of perfect rationality), and how that individual behavior adds up to some aggregate outcome. Crucially, it’s not just a set of slogans.

Krugman’s third type is a physical apparatus. Evidently you miscounted. But if you think you’ve provided “a carefully written verbal discussion like Hume’s essay on the balance of trade” then it isn’t just your counting that’s defective.

Your final sentence is even more bizarre. If you think it’s possible for any entity to have “only liabilities left on its balance sheet” then you need to brush up on elementary bookkeeping. If a central bank is insolvent its equity is a liability in the books of its owner, typically the government. In the central bank’s own books its equity (being negative) is an asset, so in the consolidated balance sheet of the state it’s a wash. If the central bank is solvent it’s also a wash, which provides a helpful clue as to why it doesn’t much matter.

This move by the British banks is probably the reason why it showed a record negative income on its current account in the second quarter.

Any thoughts…..?

Its real goods trade deficit with Germany continues to increase……

It has made the choice of hooking into the Rhine /Rhur industrial system whatever else happens…..

I.e it has gone for real goods over income from the PIigs (and the UK has always had a income from the rest of the world)
So this is a very big deal.

Yes, I miscounted; the fourth. I am trying to work from an explanation of how the operations actually work (my educational background is more in science than economics). You still have not told me how you think the central bank can raise interest rates when its insolvency becomes binding.

Regarding your final paragraph, the whole point of this discussion is that those who consider monetary stability to be important, which includes many of the northern European countries most notably Germany as well as me, want to avoid reaching a position in which the central bank cannot operate independently of its state owner. As I keep saying, you have to prove me/them wrong on my/their terms, because they are the eurozone paymasters.

Rebel, if I’m to tell you how the central bank can raise interest rates “when its insolvency becomes binding” you’re going to have to tell me what you mean by that.

Suppose the 1-month interest rate is 12.5%. Suppose the central bank’s net worth is -$50bn; or suppose it’s +$50bn. Suppose anything you like. Why can’t it raise that interest rate to 13% or 14% or whatever it pleases? What’s to stop it from simply putting bids into the interbank market?

If the answer is “nothing” then there’s no sense in pretending there’s some potentially binding constraint which is removed only when the central bank is solvent.

If the answer is, that’s not the way the central bank likes to operate, who cares? All I’m claiming is that an insolvent central bank can still control inflation, not that it can do everything exactly as it did when it was solvent.

Base money must become Government money.

Banks of any kind have really nothing to do with money…they do credit do they not ?

Dispute this………..

Steve from Virgina.
Credit money expansion (Banks) replaces a great debt with another, greater debt. There is never a net reduction in the debt, only a perpetual increase.
(Dork – we in Ireland are reducing our debt by exporting our debt / symbolic wealth via goods export elsewhere destroying internal commerce)

Treasury money expansion is repudiation of debts => repudiation of (pre-existing) money, institutionalized default (expansion includes purposeful inflation).

Finance offers fiat debt then demands repayment in circulating currency (gold clause effect). Fiat currency offered by the government to retire fiat debt: both the debt and the currency are extinguished at once.

The creditor says, “You owe us, you must pay with circulating money!”

The debtor says, “There is no circulating money, the creditors refuse to lend …”

The creditor says, “We will seize your property instead and destroy your economy!”

The government (which is also a debtor) says:

– “We will create money without borrowing and repay the loans as they come due. We can do this because we are the government, our money is paid to our army.”

– “The loans are fiat — they were created by the lender with the stroke on a keyboard, they were not made from circulating currency. To act as if they were is a crime, a false claim. The lenders will be repaid by a stroke of the keyboard, in the same form as the debts were issued. If you or other lenders touch our property or our citizens we will throw you into prison and decide later whether to feed you or not.”

– “Because lenders have impoverished our country with endless false claims we will punish you severely whenever we can get our hands on you. You are our enemy and we will destroy you if we can, because you have sought to destroy us!”

Thanks Kev. That’s what I thought, but I wanted you to confirm it. To raise interest rates to restrain the velocity of base money, you expect the central bank to create more base money – ie to cover the interest on the loan that the central bank bids for in the interbank market.

As often with these arguments, it comes down to a difference of opinion about whether or not it is acceptable to use money creation to tackle the problem in question. We will never agree, because people like me will rule out money creation as a solution and say that there is a problem, and people like you who consider money creation as a legitimate tool of economic management will say that there is no problem. As long as we can track the source of our difference down to this factor rather than accusing the other side of not understanding, people can make an informed choice between alternative policies.

Thanks for the discussion.

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