Jul 21, 2022, 5:09 am ET
Jul 21, 2022, 5:09 am ET
Unlike other monetary policymakers, officials at the European Central Bank have the added challenge of setting policy for many different countries, each with its own fiscal policy, economic outlook and debt level.
As the bank tightens its easy-money policies by raising interest rates and ending its multi-trillion-euro bond-buying programs, it is also trying to prevent government borrowing costs from diverging sharply across the eurozone and hampering the performance of monetary policy.
On Thursday, the bank is expected to announce more details of the new policy tool it is designing to stop borrowing costs rising out of sync with the country’s economic fundamentals.
These differences between countries are most clearly reflected in government bond yields, a measure of government borrowing costs. Investors will demand higher yields from countries they consider riskier to lend to, perhaps because of a history of debt defaults or political instability or slow economic growth.
Borrowing costs for Italy, which has one of the biggest debt burdens in the eurozone, rose sharply after the European Central Bank reaffirmed plans to raise interest rates. They rose again this week as the country’s government collapsed, with Prime Minister Mario Draghi resigning on Thursday after key parts of the coalition government abandoned him. The difference, or spread, between 10-year government bond yields in Italy and Germany is now roughly double what it was at this time last year.
The European Central Bank considers the sudden disconnect between government borrowing costs and economic fundamentals to be so-called market fragmentation. He said he would not tolerate this as it would reduce the effectiveness of other monetary policy tools to reduce inflation.
“It is critical that funding conditions move broadly in sync across the eurozone as we change our stance,” Luis de Guindos, the bank’s vice president, said earlier this month. “For two equally stable firms in the euro area, a change in the stance of monetary policy should lead to a similar reaction in their financing conditions, regardless of which country they are in.”
In late June, the bank announced that from early July it would implement its first line of defense against fragmentation by directing the reinvestment of maturing bond proceeds into its €1.85 trillion pandemic-era bond-buying program (1 .88 trillion dollars). to sovereign bonds that would best support the monetary policy objective of consistency. For example, it could use the proceeds of maturing German bonds to buy Italian debt.
At the same time, the bank said it was working on a new tool to stop widely diverging borrowing costs for some countries. Internal disagreements had to be overcome over the design of this tool to ensure that it did not encourage governments to be fiscally irresponsible in the belief that the central bank would come to the rescue.
The central bank has been through this battle before. At the height of the eurozone’s sovereign debt crisis a decade ago, the central bank sought to create a policy tool to match the pledge by Mr Draghi, then president of the European Central Bank, to do “whatever it takes” to save the euro. Many political and legal challenges were met.
Ultimately, the tool, which would have allowed the bank to make unlimited purchases of a country’s debt if the country was part of an official bailout and reform program, was never used.
The new instrument is expected to come with fewer conditions for a country to take advantage of it.
show more
Add Comment