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The ECB’s Transmission Protection Instrument

by Jürgen Matthes

Reforming Economic and Monetary Union

The Transmission Protection Instrument (TPI) of the European Central Bank (ECB) fills a gap in the Economic and Monetary Union governance framework. It is designed to allow bond purchases of individual euro states under certain circumstances in order to contain unwarranted interest rate hikes. At the same time, it has significant shortcomings in its current design. How should the TPI be assessed in this context and how can the Economic and Monetary Union be reformed to better integrate or replace the TPI?

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On the one hand, the TPI can protect euro area countries from abrupt and unwarranted interest rate hikes in times of multiple crises. If interest rate spreads were high, the transmission of the ECB's monetary policy to the economy and thus the primary objective of price stability would be jeopardized. However, replacing the TPI with the Outright Monetary Transactions (OMT) programme in its current form would be insufficient, as the OMT programme requires external reform conditions set by the European Stability Mechanism ESM (ex post conditionality). This would not be appropriate for euro area countries with sound economic policy and economic fundamentals that are nevertheless affected by interest rate hikes.

On the other hand, the TPI may give highly indebted countries incentives to pay less attention to fiscal sustainability, among other things because of unclear conditionality. Moreover, it remains unclear how the ECB is to distinguish between a warranted and unwarranted increase in interest rate spreads. Moreover, the ECB’s discretion in interpreting the eligibility criteria for euro states is overly large. Furthermore, there are certain doubts whether the TPI is compatible with European and national law.

The planned reform of the ESM will create the new Precautionary Conditioned Credit Line (PCCL), an instrument which like the TPI is based on ex ante conditionality. The use of the TPI could be linked to the use of the PCCL. This would make the TPI part of the democratically legitimised and legally secure ESM. The TPI could also be replaced by a reformed OMT programme, which would be linked to a specific ESM programme that is designed according to the solidity of a country's economic policy. However, if the TPI is applied in its current form, it should be limited to sovereign bonds with a remaining maturity of one to three years, like the OMT programme, rather than the current one to ten years. 

The entire analysis "Reforming Economic and Monetary Union: The ECB’s Transmission Protection Instrument” can be read here as a PDF.

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September 28, 2022
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