The writer is a visiting professor of economics at Columbia Business School
The European Central Bank’s transmission protection instrument has been created with the best intentions. As ECB president Christine Lagarde explained, the TPI “can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro”.
There is clearly value in an instrument that backstops the euro without limit. However, to be beneficial to the EU such an instrument must not undermine sound fiscal and economic policies. In this case, the absence of effective conditionality leads to atrocious incentives for countries, politicians and, crucially right now, voters.
The ECB listed four criteria for a country to be eligible: compliance with the EU fiscal framework; absence of severe macroeconomic imbalances; sustainable debt, according to the analysis of several institutions; and compliance with other EU recommendations.
In practice, the first is suspended given the fiscal rules. The second and fourth do not seem effective since they offer large discretion for judgment by the European Commission. On the last, the commission has been giving free rides to all countries in their recovery plans (except Hungary and Poland, because of disputes about the rule of law). Whether it does this for supposedly good, Keynesian reasons or for bad, political economy reasons, is irrelevant. And, based on sufficiently optimistic assumptions, a declaration by the institutions that debt is sustainable is no real hurdle.
Moreover, the ECB must merely “consider” these criteria as “an input”.
The ECB has put itself in an impossible position. It has dulled all desirable market signals and incentives, without replacing them with any credible conditionality. The TPI is not accompanied by a fiscal backstop from eurozone countries. So, if the ECB stops intervening “based on an assessment that persistent tensions are due to country fundamentals”, the state supported will face a fiscal crisis. But the ECB will want to avoid sovereign debt restructuring, so it will be trapped into continuing support.
It is no wonder that rightwing parties in Italy brought down Mario Draghi’s government at exactly the moment they knew the ECB was about to announce the backstop for bondholders. The incentives for a new far right, Eurosceptic government to choose a responsible course are low. More likely, it will cut taxes, increase pensions and offer untargeted energy support, betting that the ECB will have no choice but to activate the TPI and continue buying Italian debt.
With the ECB providing such full insurance, the incentives to complete the architecture of the euro have evaporated as well. In a stunning development, the member states have quietly announced the abandonment of efforts to conclude the EU’s banking union by putting in place a European deposit insurance.
Most importantly, the TPI creates a dangerous lack of transparency for voters. If a coalition that is leading the polls is likely to govern badly and put a country at risk, voters have a right to know the pitfalls and see them reflected in the markets.
The creation of such a largely unconditional instrument is a mistake, and one that Draghi avoided while at the helm of the ECB. The instrument he devised at the height of the euro crisis, the Outright Monetary Transactions programme, provided all the right incentives as it could only be activated with the backing of the European Stability Mechanism, and an approved reform programme.
The coming winter will test this weak institutional set-up. As long as the eurozone does not move towards a true fiscal and banking union, it is likely to reveal the unsustainable nature of the current construction of the euro.