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With the Transmission Protection Instrument (TPI), the ECB has significantly widened its toolbox. However, the implications of the new program go beyond monetary policy. By linking bond purchases to member states following the EU’s economic governance framework, the central bank has potentially increased the size of the gun the Commission and the Council can wield to incentivize compliance. But it has also made it much harder to pull the trigger. Without reforms, the new ECB program will therefore accentuate existing deficiencies of the rulebook. The onus is now on politics to change that.
On July 21st, the European Central Bank (ECB) announced the latest addition to its monetary policy arsenal. If member states experience unjustified increases in borrowing costs, the ECB can now buy their bonds under the new Transmission Protection Instrument (TPI). This reduces the risk that panicky market sell-offs put a wedge into domestic financing costs in different member states and for ECB rate hikes to lead to inflationary outcomes in Germany and deflationary ones in Italy. In a context in which the ECB is confronted with spiraling prices and a looming recession, this is good news.
However, the implications of July's decision go beyond the realm of monetary policy. The ECB’s eligibility criteria for the new instrument rely heavily on the EU’s economic governance framework. This increases the size of the gun the Commission and the Council can wield to incentivize compliance with its rulebook. But it also makes it much harder to pull the trigger. If the Commission and the Council declare member states to have broken the rules, they could now effectively bar them from a critical instrument. This raises the stakes for doing so significantly.
Without reforms, the new ECB program is therefore likely to heighten existing deficiencies in EU economic governance. Especially the fiscal framework is too rigid on paper and too flexible in practice to serve as a constructive guideline for policy making. As it stands, the new weight attached to it will most likely increase the tendency not to enforce, which would further undermine the credibility of the framework and leave the ECB without meaningful political parameters on when to intervene.
The TPI thus puts the onus on politics. To provide the ECB with a meaningful corridor for when the application of the instrument is acceptable, the EU needs a clear, economically justified and politically-backed idea about what policies it sees as being conducive to its economic goals. And it also has to define under what circumstances it would be ready to signal to the ECB that this is no longer the case.
How the new instrument will work
The declared goal of the TPI is to ensure even monetary transmission. In plain language, this means that the bank wants to root-out the possibility that its forthcoming rate hikes prompt sudden and unwarranted spread for some member states. From the ECB’s perspective, these are problematic as they put big wedges in the borrowing costs between member states and make it difficult to navigate the complex inflationary environment it currently faces.
Under the new program, the ECB will, thus, buy government bonds with maturities between one and ten years of any member state “experiencing a deterioration in financing conditions not warranted by country-specific fundamentals”. There is no ex-ante limit to the purchases of individual bonds and their size will “depend on the severity of the risks”. However, the usage of the TPI is based on several conditions....
Nils Redeker, Deputy Director, Jacques Delors Centre
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