The unsolved issues of the new Ecb bazooka

In the logic of compromise that characterized its definition, the TPI design includes a series of precautionary aspects from the point of view of Germany and the other core countries that act as a counterbalance to selective purchases.

Besides eligibility criteria, the rules envisaged for the deactivation of the new instrument and for its coordination with the monetary policy stance are also framed in such logic. On the first point, it was specified that purchases will end when there is a lasting improvement in the transmission of monetary policy but, alternatively, also when it is considered that the persistent tensions are due to the fundamentals of the country concerned. As for the impact of securities purchased following any activation of the new shield, there is no explicit commitment to sterilization (as was the case for the SMP). However, it is difficult to imagine that a long-term liquidation of securities can be avoided, since it was decided that the purchases should not have a persistent impact on the overall Eurosystem balance sheet.

One of the most controversial aspects of the TPI architecture then concerns the risk sharing on the purchased securities. In the most recent programs (PSPP and PEPP), risk sharing was residual as the ECB has directly bought only a small share of the public debt securities issued by individual member countries. Most of the purchases were instead made by the National Central Banks, each for the securities issued by its own jurisdiction. In this way, each National Central Bank has taken exposure to its own country risk but not to that of other countries, so it would not suffer losses if one of them defaulted. In the PSPP this aspect was clarified from the beginning, while it was not addressed in the least in the presentation of the new instrument. However, it seems unlikely for the structure to be very different from that of recent programs, also considering that Germany has already raised legitimacy objections regarding the PSPP despite the very low degree of risk sharing.

More details came instead from the ECB about the placement of the new instrument with respect to the two already present in its toolbox to counter the fragmentation risk of monetary policy: the PEPP and the OMTs. The pandemic program, and in particular the flexibility in the reinvestment of redemptions on maturing securities, will remain “the first line of defense” against fragmentation risks related to the pandemic. The confirmation arrived with the subsequent dissemination of data on the distribution of reinvestments between the different jurisdictions in the two-month period June-July 2022. Indeed, data show that reinvestments have clearly favoured peripheral countries to the disadvantage of core ones. In particular, Italy and Spain were awarded purchases of 9.8 and 5.9 billion euros respectively with liquidity largely coming from the redemptions of German government bonds (€ 14.3 billion) and, to a much lesser extent, French ones (€ 1.2 billion). As a result, the cumulative deviations of actual PEPP purchases from those consistent with the capital key criterion have increased considerably.

However, it should be recalled that PEPP reinvestments have a limited capacity, not to mention that there are no guarantees that in the coming months they will remain so much biased in favour of peripheral countries. Also for this reason it is crucial to understand what are the real conditions foreseen for the use of the new tool.

Some clues have leaked – albeit indirectly – from the statements on OMTs released in July by Lagarde. The ECB President said that OMTs are the tool available to the Eurosystem to manage problems in the transmission of monetary policy “caused by redenomination risks and that are country-specific”. The old anti-spread shield would therefore seem addressed to the management of pathological cases, those in which a country is close to exiting the monetary union because its fundamentals are not in order. The new (TPI), which has less binding activation criteria, would appear instead intended for the management of situations attributable exclusively to irrational and disorderly market dynamics (see Figure 2).

In practice, however, a country’s financing problems often derive from a mix of idiosyncratic factors and disorderly and uncontrolled market reactions. For example, when Italy’s redenomination risk reached very high levels between the second half of 2011 and the first half of 2012, was it due to markets’ irrationality   and speculation against Italian public debt, or to the country’s specific fundamentals (even if at the time half of the Eurozone was collapsing)? While we may never have a clear answer to this question, its implications seem relevant to ensuring the effectiveness of the new ECB bazooka.

Marcello Minenna, General Director at the Italian Excise, Customs and Monopolies Agency

@MarcelloMinenna
The views and opinions expressed are strictly personal
Original version in Italian published on August 8, 2022