Dhe European Central Bank is working flat out on an “anti-fragmentation instrument”. With the help of this instrument, it wants to permanently limit the yield differences (spreads) between the euro states. What may only sound like a technical extension of the ECB’s toolbox has the potential to permanently change the constitution of the eurozone.
The Maastricht euro regulatory framework originally aimed to force member states to adopt a fiscally sound course through market pressure. Countries with excessive debt should be disciplined by rising spreads. From the perspective of the time, differences in interest rates between the euro countries were not an obstacle to effective monetary policy. On the contrary, they were seen as protection for the ECB from being blackmailed by over-indebted states.
ECB aid under formerly strict conditions
The euro debt crisis made it clear that this market discipline has its limits. Because panic can break out in the euro bond markets in times of crisis, widening spreads are possible even for solvent countries and destructive chain reactions are possible. In 2012, the then ECB President Mario Draghi assigned the ECB the role of emergency lender for these cases with his famous “Whatever it takes” speech. However, Draghi’s approach at the time was fundamentally different than that of ECB President Christine Lagarde today.
Ten years ago, the ECB tied its aid to strict conditions, which it left to politicians to negotiate. Only those countries could hope for support from ECB bond purchases that had previously committed themselves to drastic reform and consolidation requirements through an agreement with the European Stability Mechanism (ESM). In this way, a tightrope walk should succeed. In principle, the market mechanism should remain intact, but euro states willing to reform should be able to rely on help from the ECB under strict conditions in a crisis.
The contrast to the anti-fragmentation tool now in the air could not be greater. The notion that yield differentials could play a helpful disciplining role has largely disappeared from ECB communications. With increasing generalization, the interest rate differentials between euro countries are castigated as an unacceptable obstacle to monetary policy. Linking targeted bond purchases to any binding reform and consolidation obligations of the beneficiary states is no longer planned.
In addition, the EU institutions are completely left out when decisions are made about the use of the new instrument. Instead, the Governing Council would have complete autonomy to determine whether it felt justified in widening spreads for a particular country. The Governing Council says vaguely that the aim is to contain interest rate differentials that are “fundamentally unjustified”. But what exactly that means is something that ECB representatives have stubbornly kept silent to this day.
The ECB as a political decision-making body?
The current Italian government crisis comes just in time as a lesson in what a dangerous role the Governing Council is thereby assuming. Italian bond spreads have widened in recent days as markets fear Draghi’s departure as prime minister. How would the ECB react to such a development in the future with its anti-fragmentation tool? Would Draghi’s departure be a fundamental deterioration, allowing for spread widening? Or does it make it dependent on which party then comes to power? Would the Governing Council punish populist governments by withdrawing their protections, even if elected by a majority? Or would the ECB also buy the bonds of a populist-governed country unconditionally? Would the ECB have to decide which party to classify as “populist”? Would the ECB make a distinction between a left and a right populist? In France, for example, would she give credit to Jean-Luc Mélenchon but not to Marine Le Pen if either of them won the next presidential election?
Thinking these questions through, it becomes clear that with the anti-fragmentation instrument, the ECB would become the authority to judge national election results and give thumbs up or thumbs down to governments. Supporters of an independent monetary policy can only urgently advise the Governing Council against this path. Decisions about which government can rely on European solidarity must not be made by monetary technocrats. Only elected politicians are entitled to this. By usurping the power to decide which eurozone governments deserve credit and which don’t, the Governing Council gambles away the legitimacy on which the ECB’s independence is based. There is a way out that would solve the problem more convincingly: the ECB returning to Draghi’s approach of 2012. In this logic, ECB bond purchases only exist for countries that submit to politically negotiated conditions.
Friedrich Heinemann heads the corporate taxation and public finance research department at ZEW Mannheim and teaches economics at the University of Heidelberg.