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Will Europe’s New TPI Be an ATM?

One reason why the European Central Bank's earlier asset-purchase program was never used is that fiscally fragile governments were reluctant to submit to its robust eligibility requirements. But following the rollout of a new program that comes with much looser conditions, the balance has shifted.

NEW YORK – It has finally arrived. The European Central Bank has launched a Transmission Protection Instrument (TPI) to prevent monetary policy fragmentation within the eurozone. Announced just after the ECB Governing Council’s July 21 meeting, the TPI has overshadowed the news that the ECB will raise its policy rate by 50 basis points, which is more than expected but less than the macroeconomic situation and the price stability mandate demand.

According to the ECB’s press release, the TPI “will be an addition to the Governing Council’s toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area.” If certain pre-established criteria are met, “the Eurosystem will be able to make secondary market purchases of securities issued in jurisdictions experiencing a deterioration in financing conditions not warranted by country-specific fundamentals, to counter risks to the transmission mechanism.”

I can see the economic case for creating a facility to act as a market maker of last resort, or rather as a buyer of last resort when market liquidity is materially impaired in sovereign debt markets (and in systemically important private securities markets). Financial markets can be fickle and unreliable. They are complex, non-linear systems that can swing chaotically from irrational exuberance to unwarranted despondency. Self-validating bouts of fear and panic can cause market liquidity to dry up. In a world of multiple equilibria, even technically efficient financial markets can generate undesirable price bubbles, resulting in self-fulfilling debt crises and defaults.

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