By Janos Allenbach-Ammann
The European Central Bank (ECB) on Thursday (21 July) unveiled a new “Transmission Protection Instrument” (TPI) to ensure that the borrowing costs for euro area member states do not diverge as dramatically as to make monetary policy ineffective.
The ECB presented this tool simultaneously as it announced an increase in interest rates by half a percentage point to fight inflation expectations.
Due to the uncertain economic prospects in the wake of the Russian invasion and spiking energy prices, interest rates on euro area government bonds have begun to diverge over the past months.
As euro area member states have different levels of public debt, a rise in interest rates influences them differently. A rising interest rate can cost the highly indebted Italian state much more than the less indebted German government.
Moreover, investors who fear for the financial stability of highly indebted member states might flee into German government bonds that are perceived as safer, thus exacerbating the unequal effect of monetary policy.
According to the ECB, this dynamic is a problem as it makes it hard for its monetary policy to have the intended effect in the entire euro area. And it is this problem that the TPI is supposed to solve.
“The TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries,” the ECB press statement reads.
The TPI will allow the ECB to purchase mainly government bonds of euro area member states that experience “a deterioration in financing conditions not warranted by country-specific fundamentals.” As the ECB has unlimited firepower, it can guarantee that Italian government bonds do not get too expensive.
However, the ECB binds the TPI to certain criteria, which euro area governments must fulfil if they want to profit from it.
For example, countries must comply with the EU fiscal framework and may not be subject to an excessive deficit procedure. Moreover, they may not be subject to an excessive imbalance procedure which the EU Commission can trigger in case of large macroeconomic imbalances.
Additionally, the ECB says it would also look at the fiscal sustainability of a country, and it would check whether it had “sound and sustainable macroeconomic policies” in place.
By committing itself to these criteria, the ECB is trying to preempt criticism from politicians and economists who argue that such a tool would provide a free pass to highly indebted countries and that it would not incentivise them to behave fiscally responsibly.
For economist Clemens Fuest, however, these criteria are not convincing enough, arguing that the large set of criteria implied “that financial support for individual member states will be largely a discretionary decision of the ECB.”
“Supported countries will be accountable neither to markets nor politically,” he added.
Other economists found more positive words for the TPI, however. Professor of Economics Peter Bofinger commended the ECB for the TPI via Twitter, saying it ” appears to be an intelligently designed instrument as it makes capital market support contingent on established EU rules and procedures outside the realm of monetary policy.”
By tying the monetary support more closely to the EU’s fiscal framework, reviewing the EU’s macroeconomic governance framework that has been underway since the autumn of 2021 might grow in significance.
The fiscal rules have long been a contentious issue inside the EU with governments leaving it up to the ECB to hold the euro area together during previous crisis. This often put the ECB in a difficult position, as it is supposed to be politically neutral.
By making the TPI conditional on the EU’s fiscal framework, the ECB also puts pressure on EU governments to politically decide under which conditions euro area solidarity should work.
*first published in: www.euractiv.com