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The TARGET2 controversy: Old wine in a new bottle?

The European debt crisis has triggered debates over the TARGET2 imbalances. This column discusses gold flows across Federal Reserve districts and points to the similarity of such operations to liquidity flows from Eurozone’s ‘core’ to its ‘periphery’. Though the institutional setting in Europe differs, important lessons can be drawn from the US example. Cooperation between regional Reserve Banks was essential for the cohesion of the US monetary union. Such cooperative spirit will be important for the smooth operation of the Eurozone.

The European debt crisis has triggered impassioned debate over the heretofore abstruse issue of ‘TARGET2 imbalances’. It is not too strong to say that the controversy around TARGET2 has fed doubts about the very viability of Europe’s monetary union.

Participants in this debate frequently invoke the contrast with the US, where imbalances in high-powered money flows between the 12 Federal Reserve districts are recorded in the Interdistrict Settlement Account and netted out each year (see e.g. James 2013, Koning 2012, Schubert and Weidensteiner 2012, Wolman 2013). Impressed by the American example, observers have discussed the costs and benefits of importing this mechanism into the Eurozone (Sinn and Wollmershäuser 2012).

Other proposals suggest introducing quantity or price restrictions – in the form of outright caps or surcharges – to limit the growth of TARGET2 balances (e.g. Sinn 2011). They too draw inspiration from the US experience.

In fact, prior to 1975 imbalances accumulated through interdistrict settlements were not automatically eliminated at the conclusion of the annual settlement round. Instead, settlements in gold were, formally, drawn from the reserve holdings of individual Reserve Banks on a daily basis. But the practice of daily settlement was more appearance than reality. Liquidity and banking sector tensions in a Federal Reserve district prompted the extension of mutual assistance by other Reserve Banks when it was needed (McCalmont 1960 and 1963). Reserve Banks effectively mutualised their individual gold reserves in emergency situations, creating gold flows from districts with payment surpluses to those with deficits. These flows were known as interdistrict accommodation operations.

These gold reserve sharing operations mainly took the form of rediscounts of discounted paper between WWI and the Great Depression and sales of participations in open market operations subsequently. They did not require the physical transfer of gold but only bookkeeping operations. Gold flows across districts in these exceptional situations were similar in spirit to liquidity flows via TARGET2 from the Eurozone’s ‘core’ to its ‘periphery’.

Gold reserve operations in Federal Reserve districts

In a new study (Eichengreen et al. 2014), we analyse gold reserve sharing operations by the 12 Federal Reserve districts between 1913 and 1960 (the last year for which such data are available, although the practice of daily settlements continued, as mentioned, through 1975). These operations span nearly five decades, significantly longer than modern time series for either TARGET2 or Interdistrict Settlement Account balances.

We show that mutual assistance was common in response to liquidity crises and bank runs, with Reserve Banks regularly pooling their gold reserves. Figure 1 shows the stock of interdistrict gold reserve sharing operations during the Federal Reserve System’s first five decades. It looks strikingly similar to the familiar TARGET2 ‘trumpet’ in 1920-21, in the early 1930s and after WWII.

Figure 1. Interdistrict accommodation operations – 1913-1960 (Breakdown by district)

Note: The figure shows the evolution of the outstanding amount (scaled by US GDP) of interdistrict accommodation operations undertaken over the period 1913Q4-1959Q4. Amounts are broken down by Federal Reserve district and type (i.e. whether a district was a net recipient (negative figures) or net provider (positive figures) of gold). Cumulated flows per quarter are shown for the period 1916-1918 and 1922-1926 as stock data were not available.

Fortunes could change quickly, however. Reserve Banks took turns as emergency recipients and providers of gold. Whether they gave or received depended on the nature (and incidence) of the shock, and the nature of the shock differed over time, from commodity price shocks in 1920-21 and 1930-31 to external financial disturbances in 1933 and 1946. This is illustrated in Figure 2, which maps the geographical distribution of gold reserve sharing operations in selected years.

Figure 2. Geography of interdistrict accommodation operations – ‘core’ vs. ‘periphery’.

Note: The figure depicts the geographical distribution across Federal Reserve districts of interdistrict accommodation operations undertaken in the second quarter of 1920, first quarter of 1933 and second quarter of 1946. Each shade corresponds to a specific position (dark grey = districts that were gold reserve providers; light grey = districts that were gold reserve recipients; white = no active participation). Note that the map is drawn on the basis of state boundaries, which do not systematically overlap with those of Federal Reserve districts.

As a result, payments imbalances did not grow without bound, instead narrowing when liquidity shocks ebbed, with half a shock to interdistrict accommodation typically dissipating after five quarters. Only in one instance – immediately before the bank holiday proclaimed by President Roosevelt in March 1933 – did mutual assistance give rise to significant tensions between Reserve Banks. All this suggests that reserve sharing by Reserve Banks was essential to the cohesion and stability of the US monetary union.

Lessons for TARGET2

Part of the interest of this history lies in the light it sheds on the controversy over TARGET2 balances. That mutual assistance between Reserve Banks was common during liquidity crises and bank runs suggests that the increase in TARGET2 balances since the outbreak of the global economic and financial crisis is an intrinsic part of the adjustment mechanism in a cohesive monetary union. That fortunes could change quickly, with earlier gold recipients turning subsequently into gold providers, indicates that the notion of core or periphery regions within a monetary union is not necessarily carved in stone – something that provides scope for co-insurance or risk sharing. The fact that imbalances tended to narrow once liquidity shocks subsided is at variance with concerns that TARGET2 imbalances will necessarily grow without bound.

The situation in Europe differs, for example, with regard to the details of the institutional setting. Still, that cooperation between regional Reserve Banks was essential to the cohesion of the US monetary union and its stability indicates that maintaining such cooperative spirit will be important for the smooth operation of the Eurozone.

Disclaimer: The views expressed in this paper are those of the authors and do not necessarily reflect those of the ECB, the Eurosystem or the Federal Reserve System.


Eichengreen, B, A Mehl, L Chițu and G Richardson (2014), “Mutual Assistance between Federal Reserve Banks, 1913-1960 as Prolegomena to the TARGET2 Debate”, NBER Working Paper, No. 20267, June 2014.

James, H (2013), “Designing a Federal Bank”, VoxEU.org, 18 February.

Koning, J P (2012), “The Idiot's Guide to the Federal Reserve Interdistrict Settlement Account”, 5 February 2012.

McCalmont, D (1960), Redistribution of gold reserves among Federal Reserve banks, PhD Dissertation, Johns Hopkins University.

McCalmont, D (1963), The sharing of gold reserves among Federal Reserve banks, Columbus, Ohio State University.

Schubert, M and B Weidensteiner (2012), “Can the U.S. Provide an Example of How to Limit Target2 Balances?” Economic Insight, Economic Research, Commerzbank.

Sinn, H W (2011), “The ECB’s Secret Bailout Strategy”, Project Syndicate, 29 April 2011.

Sinn, H W and T Wollmershäuser (2012), “Target Loans, Current Account Balances and Capital Flows: the ECB’s Rescue Facility”, International Tax and Public Finance, 19(4), pp. 468-508

Wolman, A (2013), “Federal Interdistrict Settlement”, Economic Quarterly, Federal Reserve Bank of Richmond, 99(2), pp. 117-141.

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