The ECB’s Target2 activities are not constraining German credit growth

Cross-posted from Credit Writedowns

Perhaps you have seen Hans-Werner Sinn’s incendiary commentary from 1 Jun on the ECB’s stealth bailout. Well, Karl Whelan who has many years’ central bank experience finds that “Professor Sinn’s analysis is incorrect and that his policy prescriptions are extremely dangerous”. He wrote a recent post at Vox, which Credit Writedowns carried yesterday under the title The ECB is not conducting a stealth bailout.

Willem Buiter is now out with a commentary on the same issue corroborating Whelan’s view. Below are the bullet points he highlights in his analysis for Citigroup followed by the full article.

This is seriously technical stuff, but still very important. I have underlined the key bits because his argument ties in with something I have been banging on about for some time, namely that banks – in Germany or elsewhere – are not reserve constrained in a convertible floating exchange rate credit system.

Banks are never constrained by reserves or reserve ratios. Banks are capital constrained. In our fiat money system, the central bank uses reserves in the system to help the it hit a target interest rate. So, the central bank provides the system with enough reserves to meet any reserve ratio at its target rate. The reserves are about helping set interest rates, not about pyramiding money on a reserve base.

Banks are never reserve constrained

I don’t think the ECB has made a secret about the ways in which it is exposed to the periphery in providing liquidity. My sense is that the ECB wants the EFSF to take on more of the burden. But, for political reasons, Europe can neither provide credible terms on the EFSF facility or permit burden-sharing by bailing in creditors. In any case, here are Buiter’s points. Enjoy.

  • We review recent articles by Martin Wolf and Hans-Werner Sinn on the role and interpretation of intra-Eurosystem (Target2) credit imbalances. We dispute their conclusions on both conceptual and empirical grounds.
  • Target2 is the payment and settlement system in the euro area for euro transactions between national central banks (and some private participants) with central bank money.
  • Increases in Target2 net liabilities of, say, the Central Bank of Ireland (CBI) should not be automatically interpreted as financing of Irish current account deficits.
  • The ECB, like any other major central bank, targets an interest rate, not money or credit stocks – those are endogenously/demand-determined by commercial banks.
  • Increases in CBI Target2 net liabilities thus do not cause reductions in central bank credit for German, or indeed any other euro area country’s, banks.
  • The stock of net Target2 claims of the Bundesbank does not reflect its exposure to risk and financial losses of other euro area central banks – the right measure would be the total exposure of the Eurosystem multiplied by the adjusted ECB capital share of the Bundesbank.
  • The Interdistrict Settlement Account procedures of the Federal Reserve System do not prevent sustained interdistrict credit imbalances.
  • Intra-Eurosystem credit and Target2 imbalances primarily reflect the difficulty of obtaining private market funding for euro area periphery banks. While a serious issue, we argue this is conceptually distinct from the case made by Wolf and Sinn.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Ramanan

    Yes no secrets.

    These things are there in the Euro Zone legal framework

    Article 4, a says:

    “The ECB and each of the NCBs shall operate an interlinking
    component to enable the processing of cross-border
    payments within Target. Such interlinking components
    shall comply with the technical provisions and specifications, which are available on the ECB’s website
    ( and updated from time to time.”

    Article 4 Interlinking Provisions (b)-1 :

    “The ECB and each of the NCBs shall open an inter-NCB account on their books for each of the other NCBs and for the ECB. In support of entries made on any inter-NCB account, each NCB and the ECB shall grant one another an unlimited and uncollateralised credit facility”

    b-2 says:

    “To effect a cross-border payment, the sending NCB/ECB
    shall credit the inter-NCB account of the receiving
    NCB/ECB held at the sending NCB/ECB; the receiving
    NCB/ECB shall debit the inter-NCB account of the
    sending NCB/ECB held at the receiving NCB/ECB.”

    The Annual Accounts of the ECB 2009 ( on Page 9:

    “Intra-ESCB transactions are cross-border transactions that occur between two EU central banks. These transactions are processed primarily via TARGET2 – the Trans-European Automated Real-time Gross settlement Express Transfer system – and give rise to bilateral balances in accounts held between those EU central banks connected to TARGET2. These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. This position in the books of the ECB represents the net claim or liability of each NCB against the rest of the ESCB”

    etc etc etc.

  2. Birch

    Oh, I get it finally. Reserve requirements are just a crude interest rate tool. Canada got rid of reserve requirements because the Bank of Canada sets its overnight lending rate, so reserves are redundant.

  3. Ralf T

    I´ve actually bothered to read through most of the linked documents (Sinn´s articles as well as Whelan´s, Storbeck´s, Wolf´s, Salomon´s; still reading on Buiter´s). Whilst it does seem that even Whelan agrees, that Germany would face some loss in case of an Irish(/and or Irish central bank)default, even if only to the extent of it´s share in case of a recapitalization of the central bank, the second claim that Sinn makes seems even more nonsensical:
    His claim for a credit squeeze in Germany, given his example(Irish farmer borrows from Irish bank, which borrows from Irish central bank, which “prints” the money; money is transferd from farmer to tractor manufacturer; Bundesbank has a target2 claim on ECB, which has a target2 claim on the Irish central bank).
    Sinn concludes from this that the Bundesbank will be restrained from extending credit to domestic banks and hence the domestic german economy.
    But what about the funds transfered to the tractor manufacturer? Before the crisis these funds might very well have been invested in the booming Irish market, now they will most likely be invested domestically.
    This is even more true, when leaving this simplistic example and focussing on pure capital flight from e.g. Ireland/Greece/Portugal or even Spain. The logical result from this would be a glut of capital and financing in Germany, not a constraint(especially if more informed Irish/Greek/… investors buy bonds/shares/real estate…) in Germany directly instead of just depositing the transfered funds. But even deposited funds would seem to at the very least net out any reduced funds available from the Bundesbank.
    A target2 surplus for the Bundesbank is just the logical result of the capital flight(from the PIIGS)/reluctance by Germans to invest abroad.

    If Sinn had complained about a glut of funds flowing into Germany and quite possibly causing problems in the future, he may have had a point.

  4. Ralf T

    finally finished Buiters paper. The essential message Buiter->Sinn seem to be “you don´t have the first clue about how monetary policy/systems work in the real world”(“The statement by Professor Sinn (2011): “Moreover, strict crowding out
    is inevitable if the ECB controls the overall stock of central bank money in the
    Eurozone by way of sterilising interventions or auctioning off limited tenders.” is
    therefore not a characterisation of any interest-rate setting and credit auctioning
    regime that the ECB has ever implemented.”)

  5. Philip Pilkington

    Dammit! I should have written about this instead of posting comments about it.

    For a little more comprehensiveness, a few points:

    (1) Yes, Sinn seems to view the Eurosystem as one that transfers wealth from certain nation-states to certain other nation-states — namely, from Germany (oh, Sinn’s German, really?) to Ireland — through certain bank balance-sheets. This is rhetoric dressed up as central banking.

    (2) The way he thinks this operates is through the following: the Irish central banks ‘print’ money and then transfer them to German banks to pay for imports from Germany — this causes crowding out and inflation… blah, blah, blah…

    (3) All this assumes that national central banks operate under their own, I dunno what to call it… pseudo-sovereignty, maybe? Anyway, they don’t. The ECB is the Big Daddy here. It’s the one that balances these things. This isn’t a competition between who can create the most Eurobucks in the Target II account to ‘steal’ imports from other countries.

    (4) Let’s cast this in MMT terms. The ECB is like the Fed. So they issue currency to national banks based on how much collateral these banks hand over and provided they are willing to pay the exchange-rate. To put it in more simple terms: national banks in the Eurosystem are NOT reserve constrained.

    (5) Sinn is still (mentally) operating in a gold-standard system. He thinks that reserves determine loans and these determine spending. So, he sees money extended to the Irish banks as being money that is ‘taken away’ from German banks (“They tuk our jiiiiibs!!!”). This is not the case. German banks can get as much money they want — but it will cost them in interest etc. just as it does for the Irish banks.

    The whole thing is a farce. But a wonderful example of the poverty of mainstream macroeconomic theory and more proof that, in the real world, only wackos believe that reserves constrain lending and that the central bank exogenously determines the money-supply.

    (Don’t believe me? Read it for yourself — Sinn is a monetarist who believes that the ECB ‘control the money-supply’: ““Moreover, strict crowding out is inevitable if the ECB controls the overall stock of central bank money in the Eurozone by way of sterilising interventions or auctioning off limited tenders.”

    ‘Controls the overall stock of central bank money’? Can I get a tin-foil hat for this guy?)

    1. Philip Pilkington

      “So they issue currency to national banks based on how much collateral these banks hand over and provided they are willing to pay the exchange-rate.”

      That should read: “…pay the interest-rate”. Sorry.

  6. charles 2

    With all due respect to Mr Buiter, he is a bit disingenuous in his arguments :
    a) the overnight lending mechanism is meant to be an emergency one, for back-office glitches purposes. Thinking that the ECB does not look carefully at various quantities of money is preposterous. It is in that context that “crowding out” could occur.
    b) it is not the FRB who may-ot-may-not sterilize money creation by the deficit district, the FRB merely instructs the surplus district to do so. In that sense, credit in, say, Alabama has an impact on credit in, say, New York.
    c) the loss sharing agreement is NOT compulsory. Art. 32.4 of the treaty states (emphasis mine) “The Governing Council may decide that national central banks shall be indemnified against costs incurred in connection with the issue of banknotes or in exceptional circumstances for specific losses arising from monetary policy operations undertaken for the ESCB”. “may” not “shall” ! This is a very big difference, especially in the context of “out of ESCB” refinancing such as Irish ELA. I expect the Greeks to resort to the same expediency soon. If there is no loss indemnification, the future flow of allocated seignorage rights will be de facto collateralized in favor of inter-NCB debt. Visibly, Herr Sinn thinks (quite rightly IMHO) that this collateral is not sufficient and asks for more. The key sentence of his paper is “Target liabilities have to be paid annually with gold, currency reserves, or other marketable assets”.Some want greek ports and power plants, other want gold and foreign currencies. It is collateral collection time !

    1. Philip Pilkington

      The ECB will re-compensate. Christssake. Get out with your gold-standard nonsense. If losses are incurred the ECB will print up Eurobucks — or, more accurately, credit them to the account of the German banks.

      Where do they come from? Magic-land. Same place that QE came from in the US. Bernanke’s magic wand. In this case Trichet’s.

      Sinn is a gold-bug and an ideologue. I’ll bet most of his colleagues are cringing to no end.

      1. Philip Pilkington

        Anyway, my understanding is that Sinn doesn’t even highlight losses. He thinks that these accounts ‘distort capital flows’. The irony, of course, is that he is the one distorting capital flows.

        Because he still sees things in a gold-standard flow model where gold is shipped from one sovereign to another — or, at least, some obscure money-equivalent to gold (don’t ask me how this works, it’s Sinn’s fantasy not mine…).

        He doesn’t complain about getting the money back. He’s complaining about ‘crowding out’. This is just bizarre. So, by Ireland buying German goods, German borrowing will be crowded out? Really? How? By the interest-rate? Nope. Obviously not. So, how?

        By the gold-reserves that are limited in numbe… oh yeah… fiat system… right…

  7. RebelEconomist

    I do think that Sinn has a point here, and, whatever, he (or Whittaker) deserves huge credit for raising this issue. Because the ECB, via the NCBs lends to PIGS banks on terms that the private sector will not (ie against lowly-rated government bonds), the PIGS will account for an increasing proportion of money creation in the eurozone. However, I agree with Buiter that this is funding capital flight from the PIGS banks as much as their current account deficits, and I agree with the proposition here that this is not constraining credit growth to Germans (Sinn himself suggests that the alternative would be for the Irish farmer to borrow from a German bank to pay for his tractor).

    I don’t think any of this depends on arguments about MMT though.

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