This paper was provided by the Policy Department for Economic, Scientific and Quality of Life Policies at the request of the Committee on Economic and Monetary Affairs (ECON) ahead of the Monetary Dialogue with the ECB President on 20 June 2022.
The ECB is about to enter the tightening part of the monetary policy
cycle. Unlike in the easing part of the cycle, when the two objectives
of monetary and financial stability are generally jointly served by the
same policy, ECB policy interest rates hikes to tame inflation pose a
risk of financial fragmentation in the euro area. Some countries might
experience a significant widening of their spreads not necessarily
driven by fundamentals. This fragmentation could put a strain on the
ability of those countries to borrow. Therefore, the ECB should design a
specific tool that will accompany interest rate hikes to neutralise the
risk of fragmentation directly for countries facing it, while staying
within the bounds set by the EU Treaties and ensuring political
legitimacy. We also advocate structural changes to the ECB’s collateral
framework to avoid unnecessary uncertainty about the safe asset status
of European sovereign bonds.
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