31 May 2012US Economics Digest
Let's Settle This: TARGET2 vs the Interdistrict Account
Two months before his eight-year term as European Central Bank president ended, Jean-Claude Trichet addressed the Kansas City Fed's August 2011 Jackson Hole conference.
Trichet compared the euro area with the US, arguing that economic diversity within the twowere similar:
It is often assumed that the US economy would be significantly more homogenous thanthe economy of the euro area
Looking more closely at the regional dispersion acrossUS regions and euro area economies does not confirm this ... The dispersion of many of the key indicators is surprisingly similar.
This may be accurate, but more structural reforms are needed before the euro area canfunction comfortably like the US
with a single currency and monetary policy rate. Thecrucial difference is clear: The federal legal and fiscal systems under which the 50 unitedstates operate do not have supranational counterparts in the euro area; each system inthe euro zone is still controlled by the region
17 individual sovereign countries.Several other
“compare and contrasts”
can be drawn between the Eurosystem and theFederal Reserve System
In normal times, for example, flows of money to settle transactions
between the euro area’s National Central Banks (NCBs) resemble those between the Fed’s
12 District Banks. But in times of financial stress, the very diversity of which Trichet spokeexposes significant dissimilarities in flows within these two economic blocs.Flows between NCBs are cleared via the Euro
pean Central Bank’s
mechanism.Flows between Fed District Banks are cleared via the
Federal Reserve System’s
Interdistrict Settlement Account (ISA)
. While there are many similarities between thetwo accounting processes, it is important to recognize their fundamental differences:1. Bilateral balances between pairs of Fed District Banks are settled once each year,resulting in zero (or near-zero) net balances. But the outstanding net balancesbetween NCBs
and between the sovereigns that own them
have beenpermitted to keep growing over time (Exhibit 1).2. TARGET2 liabilities are ultimately claims on the ECB, and a claim on the ECB isultimately a claim on each nat
ion according to that nation’s percentage ownership
of the ECB. But ISA liabilities are not claims on the Federal Reserve Board; theyare claims on other District Banks. And claims on District Banks are in principleultimately claims on the private banks that own them (not on the government).3. Nationwide banking and deposit insurance in the US suggest that interdistrictflows tend to reflect nothing more than normal commercial transactions. Incontrast, the persistence in the main of country-by-country banking in the eurozone means that some (large) fraction of flows among NCBs may reflect capitalflight and loss of confidence in the underlying banks.
A Tale of Two Structures
The Eurosystem and the Federal Reserve
In the euro area, the central banking system is structured as a combination of NCBs, suchas the Banque de France and the Bundesbank, under the coordination of the ECB.Monetary policy (setting policy rates, conducting open market operations, etc.) iscontrolled by the ECB, which has its own balance sheet and capital.The euro zone NCBs, currently numbering 17, retain their individual identities, with eachalso maintaining its own balance sheet and capital. The NCBs own shares in the ECB,
determined by the GDP and population of their respective nations (i.e., the “capital key’
formula). Profits (and losses) on ECB monetary operations are distributed to the NCBs inproportion to their ownership of the ECB. In turn, the NCBs can pass any profits through totheir respective national governments (Flood and Garber, 2000).