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The End of the EU’s Free Lunch

For many years, the European Central Bank was able to print money to purchase member states’ government debt without having to worry about causing high inflation. But now that stagflationary conditions have set in, the ECB finds itself on the horns of a dilemma.

MUNICH – Until recently, the European Central Bank could simply throw money at the eurozone’s problems. But that is no longer possible in the face of inflation, so it has now developed a new “anti-fragmentation” mechanism – the Transmission Protection Instrument (TPI) – to protect highly indebted member states in the event that their borrowing costs (sovereign-bond yields) rise much higher than those of less indebted member states. Should the need arise, the ECB will swap out low-debt member states’ bonds for those of high-debt member states in its portfolio, thereby reducing the interest-rate differential between them.

And who will decide whether there is indeed a need for such action? The ECB will – all by itself.

The TPI is problematic for many reasons, not least because interest-rate spreads are an integral part of a properly functioning capital market and federation. It is worth bearing in mind that while yield spreads refer to the nominal interest rates agreed on paper, these interest rates are not paid at all in the event of bankruptcy.