The ECB’s Political Overreach
The European Central Bank’s new Transmission Protection Instrument is as ambitious as it is risky. Not only does it involve the central bank in tasks that lie far outside its remit, but it has also been unveiled at a time when monetary policymakers should be focused squarely on maintaining price stability.
FRANKFURT – In mid-June, as the yield on Italian ten-year bonds was rising to around 250 basis points above that of German bonds, the European Central Bank felt it necessary to hold a special Governing Council meeting to announce accelerating work on a new “anti-fragmentation” measure. And now, it has unveiled the fruit of its effort.
The ECB’s Transmission Protection Instrument is supposed to “ensure that the monetary policy stance is transmitted smoothly across all euro area countries,” according to the official announcement. “The TPI will be an addition to [our] 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.”
The TPI is an ambitious and risky undertaking for the ECB, considering how difficult it is to determine the extent to which spreads (the difference between different countries’ bond yields) reflect differences in underlying fundamentals, as opposed to unjustified and destabilizing market dynamics. Moreover, there will always be a significant political element in such judgment calls, which ensures that they will be tested by markets. As a result, the ECB inevitably will feel greater pressure to intervene more strongly than is justified by the economic and financial fundamentals of the country concerned.