When Bundesbank President Joachim Nagel talks about the latest plans of the European Central Bank (ECB), he becomes quite clear. Anyone who feared that the friendly man from Karlsruhe might act too conformistly as Jens Weidmann’s successor on the Governing Council has been taught a lesson. There is a struggle for a new instrument for the ECB: it has so far been known under the unwieldy name “Antifragmentation Instrument” or the no less unwieldy internal name “Transmission Protection Mechanism”, or TPM for short. The central bank wants to introduce the new tool next week – together with the first interest rate hike in the euro area in eleven years. At least in the way that many in the ECB imagine the new options for intervention, Nagel rejects them. He is supported, for example, by Austria’s head of the central bank, Robert Holzmann.
The resistance is justified. Not only that the necessity of the new instrument is not clearly documented. Depending on the design, it can also be legally tricky. And last but not least, there is the danger that it will send out the wrong economic signals to heavily indebted euro states.
The details of the instrument are still being debated, but the basic model looks like this: the ECB is afraid that the forthcoming interest rate hikes could throw the yields on bonds from individual heavily indebted euro states out of control. That’s why she wants to create the possibility of buying up their bonds if the yield deviates too far from the German government bond or if the yield rises too quickly. In theory, this purchase should be possible indefinitely, so that investors on the bond markets have no chance to speculate against it. This is reminiscent of former ECB President Mario Draghi’s announcement in 2012 that he would do “whatever it takes” to save the euro.
More than 8 percent inflation in the euro area
Unlike then, however, the ECB is now facing a good 8 percent inflation. It has therefore deliberately stopped buying new bonds that are no longer necessary from a monetary policy perspective. With new purchases, the central bank would find itself in need of explanation. She is trying to solve this by announcing the “sterilization” of such purchases: the monetary policy effect is to be offset by other steps, such as auctions, where banks can park money at the ECB on favorable terms.
The central argument of the ECB for the new instrument is: “Transmission” is necessary for its monetary policy, the transfer of monetary policy steps to all euro countries. This would be disturbed if, for speculative reasons, for example through bets on the financial market on the default of individual government bonds, yields rose and the euro area fragmented. However, it is unclear what the ECB means by “speculative reasons” and how it intends to determine this in real time. The real fear behind this is that of a new euro crisis.
Now nobody wants a new crisis in the euro area. But even if the yield in Italy, for example, has risen after the announcement of the ECB interest rate hike: it is far from the 7 percent seen in the euro crisis. In addition, the reinvestment of funds from maturing bonds from old ECB programs already offers control options.
The new instrument is legally tricky. Depending on how it is designed, it comes very close to prohibited state financing. The first euro plaintiffs are coming back. Finally, there is an existing ECB tool that works very similarly: it’s called the OMT. However, if states make use of it, they have to meet conditions – which is probably one of the reasons why it was never used. If the new instrument had no conditions, its legal status would probably be difficult. It is therefore more likely that there are conditions, but soft ones: for example, to follow the budget recommendations of the EU.
The ECB has not yet revealed the exact limits of its intervention and probably does not want to. Either way, they’re getting close to capping the interest rates of indebted countries on their sovereign debt. However, capping bond yields is economically tricky: after all, the yields also include the risk premiums of the financial markets. They are a signal that disciplines the budgetary policies of the states and creates incentives for reforms – especially in times when the fiscal rules are interpreted very broadly. It is not the task of the ECB to overturn this. Their mandate is price stability.