Feed the essay to ChatGPT and ask the questions that you have. I found it useful to ask it to walk through an example transaction showing how a QE operation gets financed by a TARGET2 balance.
Was the Euro not a leftist Franco-German scheme to subjugate Europe from the beginning? It was not intended to be a successful monetary scheme for all the reasons you have outlined. The outcome is its reason for being. Perhaps it is working too well….
Hard to believe we are still debating Target 2 balances in 2025! Sure, if the euro area falls apart the monetary balances between countries, which quite obviously must exist in a monetary union, become a fiscal balance. Wouldn't that be the same if California were to secede from the US and the Fed system?
The outlined ECB operations are no mystery (including the fact that QE was essentially hidden government financing with high spreads for banks as intermediaries) EXCEPT for Target2. The latter is a simple cash management system within the Euro area. Like any such system, it balances credits and debits of national central banks: some have cash, others owe it. There is no requirement to settle positive/negative balances (under the Fed structure, my understanding is that balances must be settled once a year). In early 2011, a retired Bundesbank Director studied the Annual Report of the Bundesbank and noticed that there were unidentified assets of about €300B. He asked the renowned German economist Hans-Werner Sinn what these assets might be. And Sinn subsequently revealed to the world the magic of Target2: a system where money can flow to surplus countries without the deficit countries needing to have the cash. Deficits automatically increase the claims of the surplus country. Here is a ficticious story to make the point: at the peak of the Greek crisis, a wealthy Greek met a German banker at the beach. The Greek said: "I want to transfer the €50M which I have with a Greek bank to your bank in Germany. My Greek bank tells that they can only do that if you lend them the €50M. Could you do that?" The German banker asks: "How stupid do you think I am?" Instead, the Greek simply gives his Greek bank transfer instructions for the €50M and the money flows to the German bank. No sweat. Why? Because the Bundesbank's Target2 claims against the Bank of Greece increased automatically by €50M. End of story. When stand-alone countries run out of foreign currency, they have to stop importing. When Greece went bankrupt, imports and the current account continued to run enormous deficits facilitated by Target2. Today, the Bundesbank has about €1.1TR claims against other central banks. The largest takers are Italy and Spain with well over €400B each. Followed by France and Greece with well over €100B. They are not loans or debt, they are clearing balances within the Euro system. As long as the Eurosystem survives, they don't really matter. Should the Eurosystem collapse, there is a good chance that they become hot air. This article is old but still valid: https://klauskastner.blogspot.com/2018/03/target2-claims-revisited.html
Great article, thanks Mr Cochrane! Can the increasing awareness of target2 accounts and their fiscal relevance in the population lead to inflation according to FTPL? And for which of the countries?
It seems to me that one of the conclusions from this article is that Brexit was actually astute for the Brits.
Brexit means that the U.K. avoided being pulled deeper into a structurally sclerotic system driven by the need to paper over eurozone dysfunction.
Yes, it hurt London financiers and their ecosystem in the medium term, but in the long-run the U.K. and its people are better off, mostly shielded from the inevitable disaster that will come when a sovereign and/or European banks go bust.
Which would just show yet another example that the masses were correct and the British elites are self-interested and self-serving with their claims of Brexit being an awful thing.
As a fan of your blog, I am sorry to say that you got Target2 (T2) wrong in facts and, imo, also in assessment.
Let's start with the facts:
(1) Central bank profits from the common monetary policy are shared ("monetary income pooling") within the European System of Central Banks (ESCB), with the exception of profits from (almost all) government bond purchases.
(2) In your example, BdI refinances via T2 at the deposit rate. But this part of interest income is only treated as a (negative) prepaymemt to the general monetary income pooling (see (1)). Therefore, there is no net return/yield on T2. The ECB deposit rate does not impact the sum of income that any EU National central bank (NCB) receives from or pays for T2 balances. Because that sum is always zero after the monetary income pooling (set aside the financial (dis)advantage of receiving/paying money in advance). You missed the second step of the two-step profit distribution within the ESCB.
(3) In your example, BdI has to borrow money from the ECB (via T2) in order to buy government bonds. That is not true. If BdI buys bonds, it just creates the common currency. If the seller is an Italian commercial bank, there is no impact on T2. Only when that bank transfers some amount of money cashless to another Euro member state, BdI looses the liability towards that bank and instead acquires a liability toward the ECB. The receiving NCB gets a liability towards the recipient commercial bank that is balanced with a T2 claim via ECB. That way, transfers within the ESCB do not change NCB capital (relevant for profit distribution and potential needs for recapitalisation). An alternative would be to transfer NCB assets along with NCB liabilities which is technically difficult and politically unwanted (though economically equivalent to T2).
Assessment:
(1) If there were no NCBs but only the ECB, the same policy choices (buy government bonds, but calculate and distribute profits separately to governments) could have been implemented resulting in the same economic outcomes with no T2 balances to calculate.
(2) In fact, there is a US equivalent to T2, the Interdistrict settlement account, which is less disputed because the US Fed banks are not owned by US states and Fed district borders differ from state borders. But most of all, the probability of a US break-up is essentially zero. That is different in the Euro zone. But the reasons for this difference do not lie within T2.
(3) If we take market interest rates and estimate opportunity income losses and gains on T2, we do nothing else than to estimate what it would have cost in a fixed exchange regime to balance over time demand and supply for the individual national currencies. The resulting amount can be interpreted as an implicit transfer from core to periphery countries. In the same way, you could estimate the net money inflow/outflow for Texas and you would see that there are similar (but smaller) implicit transfers in the US. But they only become relevant if a state will leave the common currency area. Because then, people will inquire whether this state takes along more or less central bank assets than (formerly common) central bank liabilities.
That said, there are severe problems in the fiscal setup of the EU that have consequences for monetary policy and translate in extremely high T2 balances. But T2 is just the thermometer not the disease.
Seems to me that even readers with more than average understanding of economics will find this essay difficult to follow.
Suggestion: write a primer to the article.
Feed the essay to ChatGPT and ask the questions that you have. I found it useful to ask it to walk through an example transaction showing how a QE operation gets financed by a TARGET2 balance.
Thanks. The author would seem capable and honorable enough of writing a primer.
ChatGPT when I asked it who was the person with my name produced gobbledygook.
Good luck with that. The demands on the author’s time exceeds supply, so you will likely be disappointed.
In the meantime, try writing better prompts.
https://chatgpt.com/share/68ecfe27-85e8-8008-878e-45357be81a8d
“explain that really slowly using small words and no acronyms.” What a concept! I love it. Might add “concisely”.
Was the Euro not a leftist Franco-German scheme to subjugate Europe from the beginning? It was not intended to be a successful monetary scheme for all the reasons you have outlined. The outcome is its reason for being. Perhaps it is working too well….
Brendan Connelly's book, The Rotten Heart of Europe, was the best one written about that concept.
Fascinating stuff. I propose having consumption-linked perpetuities on the ECB balance sheet: https://gideonmagnus.medium.com/the-case-for-consumption-linked-perpetuities-in-the-eurozone-557779ece710
Thanks - I’ll buy the book
Hard to believe we are still debating Target 2 balances in 2025! Sure, if the euro area falls apart the monetary balances between countries, which quite obviously must exist in a monetary union, become a fiscal balance. Wouldn't that be the same if California were to secede from the US and the Fed system?
As far as I know, as a member of Target2 the ECB has a slignt difference. The ECB is a guaranee of the system. Nice. :-)
Excellent analysis, thank you! Bulgaria will join the eurozone on January 1, 2026, and will suffer serious consequences.
Thanks for the link, which is informative and kind of amazing. Maybe AI really is transformative.
It ain't what you don't know
that gets you into trouble.
It's what you know for sure
that just ain't so.
-Mark Twain
It is bad enough that
so many people believe
things without any evidence.
What is worse is that some
people have no conception
of evidence and regard facts
as just someone else's opinion.
-Thomas Sowell
The urge to save humanity
is almost always a false front
for the urge to rule.
- H. L. Mencken
The outlined ECB operations are no mystery (including the fact that QE was essentially hidden government financing with high spreads for banks as intermediaries) EXCEPT for Target2. The latter is a simple cash management system within the Euro area. Like any such system, it balances credits and debits of national central banks: some have cash, others owe it. There is no requirement to settle positive/negative balances (under the Fed structure, my understanding is that balances must be settled once a year). In early 2011, a retired Bundesbank Director studied the Annual Report of the Bundesbank and noticed that there were unidentified assets of about €300B. He asked the renowned German economist Hans-Werner Sinn what these assets might be. And Sinn subsequently revealed to the world the magic of Target2: a system where money can flow to surplus countries without the deficit countries needing to have the cash. Deficits automatically increase the claims of the surplus country. Here is a ficticious story to make the point: at the peak of the Greek crisis, a wealthy Greek met a German banker at the beach. The Greek said: "I want to transfer the €50M which I have with a Greek bank to your bank in Germany. My Greek bank tells that they can only do that if you lend them the €50M. Could you do that?" The German banker asks: "How stupid do you think I am?" Instead, the Greek simply gives his Greek bank transfer instructions for the €50M and the money flows to the German bank. No sweat. Why? Because the Bundesbank's Target2 claims against the Bank of Greece increased automatically by €50M. End of story. When stand-alone countries run out of foreign currency, they have to stop importing. When Greece went bankrupt, imports and the current account continued to run enormous deficits facilitated by Target2. Today, the Bundesbank has about €1.1TR claims against other central banks. The largest takers are Italy and Spain with well over €400B each. Followed by France and Greece with well over €100B. They are not loans or debt, they are clearing balances within the Euro system. As long as the Eurosystem survives, they don't really matter. Should the Eurosystem collapse, there is a good chance that they become hot air. This article is old but still valid: https://klauskastner.blogspot.com/2018/03/target2-claims-revisited.html
Thank you, Prof. Cochrane, for explaining this issue so nicely with your own infographics.
Second, enthusiastically.
Great article, thanks Mr Cochrane! Can the increasing awareness of target2 accounts and their fiscal relevance in the population lead to inflation according to FTPL? And for which of the countries?
It seems to me that one of the conclusions from this article is that Brexit was actually astute for the Brits.
Brexit means that the U.K. avoided being pulled deeper into a structurally sclerotic system driven by the need to paper over eurozone dysfunction.
Yes, it hurt London financiers and their ecosystem in the medium term, but in the long-run the U.K. and its people are better off, mostly shielded from the inevitable disaster that will come when a sovereign and/or European banks go bust.
Which would just show yet another example that the masses were correct and the British elites are self-interested and self-serving with their claims of Brexit being an awful thing.
As a fan of your blog, I am sorry to say that you got Target2 (T2) wrong in facts and, imo, also in assessment.
Let's start with the facts:
(1) Central bank profits from the common monetary policy are shared ("monetary income pooling") within the European System of Central Banks (ESCB), with the exception of profits from (almost all) government bond purchases.
(2) In your example, BdI refinances via T2 at the deposit rate. But this part of interest income is only treated as a (negative) prepaymemt to the general monetary income pooling (see (1)). Therefore, there is no net return/yield on T2. The ECB deposit rate does not impact the sum of income that any EU National central bank (NCB) receives from or pays for T2 balances. Because that sum is always zero after the monetary income pooling (set aside the financial (dis)advantage of receiving/paying money in advance). You missed the second step of the two-step profit distribution within the ESCB.
(3) In your example, BdI has to borrow money from the ECB (via T2) in order to buy government bonds. That is not true. If BdI buys bonds, it just creates the common currency. If the seller is an Italian commercial bank, there is no impact on T2. Only when that bank transfers some amount of money cashless to another Euro member state, BdI looses the liability towards that bank and instead acquires a liability toward the ECB. The receiving NCB gets a liability towards the recipient commercial bank that is balanced with a T2 claim via ECB. That way, transfers within the ESCB do not change NCB capital (relevant for profit distribution and potential needs for recapitalisation). An alternative would be to transfer NCB assets along with NCB liabilities which is technically difficult and politically unwanted (though economically equivalent to T2).
Assessment:
(1) If there were no NCBs but only the ECB, the same policy choices (buy government bonds, but calculate and distribute profits separately to governments) could have been implemented resulting in the same economic outcomes with no T2 balances to calculate.
(2) In fact, there is a US equivalent to T2, the Interdistrict settlement account, which is less disputed because the US Fed banks are not owned by US states and Fed district borders differ from state borders. But most of all, the probability of a US break-up is essentially zero. That is different in the Euro zone. But the reasons for this difference do not lie within T2.
(3) If we take market interest rates and estimate opportunity income losses and gains on T2, we do nothing else than to estimate what it would have cost in a fixed exchange regime to balance over time demand and supply for the individual national currencies. The resulting amount can be interpreted as an implicit transfer from core to periphery countries. In the same way, you could estimate the net money inflow/outflow for Texas and you would see that there are similar (but smaller) implicit transfers in the US. But they only become relevant if a state will leave the common currency area. Because then, people will inquire whether this state takes along more or less central bank assets than (formerly common) central bank liabilities.
That said, there are severe problems in the fiscal setup of the EU that have consequences for monetary policy and translate in extremely high T2 balances. But T2 is just the thermometer not the disease.