Bruegel: Fragmentation risk in the euro area: no easy way out for the European Central Bank

08 June 2022

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.

Bruegel

full paper

© Bruegel