Unlike other monetary policymakers, European Central Bank officials have the added challenge of setting policy for many different countries, each with its own fiscal policy, economic outlook, and level of debt.
As the bank tightens its easy-money policies by raising rates and ending its multibillion-dollar bond-buying programs, it is also trying to prevent government borrowing costs from widely diverging across the eurozone and hampering policy effectiveness. monetary.
On Thursday, the bank is expected to announce more details of a new policy tool it is designing to prevent borrowing costs from rising out of sync with a country’s economic fundamentals.
These cross-country differences are most clearly reflected in sovereign bond yields, a measure of government borrowing costs. Investors will demand higher yields from countries they see as riskier to lend to, perhaps because of a history of defaulting on debt, political instability, or slow economic growth.
Borrowing costs for Italy, which has one of the highest The debt burden in the eurozone has risen sharply since the European Central Bank reaffirmed its plans to raise rates. This week, they rose again as the country’s government collapsed, with Prime Minister Mario Draghi resigning on Thursday after key parts of the coalition government left him. The difference, or spread, between 10-year sovereign bond yields in Italy and Germany is now roughly double what it was at this time last year.
The European Central Bank considers a sudden break in the relationship between government borrowing costs and economic fundamentals to be called market fragmentation. He has said that he will not tolerate this as it would reduce the effectiveness of his other monetary policy tools in reducing inflation.
It is “critical that financing conditions move in a broadly synchronized manner across the euro zone when we change our stance,” Luis de Guindos, the bank’s vice president, said earlier this month. “For two equally strong companies in the eurozone, a change in monetary policy stance should lead to a similar reaction in their financing conditions, no matter which country they are domiciled in.”
In late June, the bank announced that, beginning in early July, it would implement its first line of defense against fragmentation by directing reinvestments of maturing bond proceeds in its pandemic of 1.85 billion euros (1.88 billion dollars). to the bonds of the countries that would best support its monetary policy objective of consistency. For example, you could use the proceeds from maturing German bonds to buy Italian debt.
At the same time, the bank said it was working on a new tool to stem widely divergent borrowing costs for some countries. Overcoming internal disagreements over the design of this tool was necessary 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 tried to devise a policy tool that would coincide with a commitment by Draghi, then president of the European Central Bank, to do “whatever it takes “to save the euro. He faced many political and legal challenges.
In the end, the tool, which would allow the bank to make unlimited purchases of a country’s debt if the country were part of a formal bailout and reform program, was never used.
The new tool is expected to come with fewer conditions for a country to benefit from it.