The ECB May Already be Captured by Fiscal Dominance

Abstract

Recent developments in French sovereign debt markets have raised important questions about the evolving role of the European Central Bank (ECB) within the euro area. While much of the increase in government bond yields across advanced economies reflects global factors, France has experienced a notable widening in sovereign spreads relative to Germany. This paper argues that the significance of these developments extends beyond concerns regarding French public finances. Instead, they highlight a broader institutional transformation in which the ECB is increasingly required to make judgements with potentially significant fiscal consequences. The paper reviews recent developments in French fiscal policy and debt dynamics before examining the ECB's Transmission Protection Instrument (TPI), introduced in 2022 to address unwarranted fragmentation in sovereign bond markets. Particular attention is paid to the instrument's requirement that market movements be "not warranted by country-specific fundamentals", a criterion that is difficult to apply objectively in practice. The paper considers whether recent French yield movements can reasonably be explained by fiscal fundamentals and compares the experience with the United Kingdom's gilt market intervention in September 2022. It concludes that the growing expectation of possible ECB intervention risks blurring the distinction between monetary policy and fiscal policy. Although France does not currently require support, the episode raises questions about whether fiscal dominance may already be emerging through expectations rather than formal institutional arrangements.