Stagflation and fragmentation – the euro area at the crossroads

The euro area may be about to experience something new: fragmentations in its financial markets in a situation characterised by a high inflation rate. In such a scenario, we argue that the euro area has only two options. First, countries facing tight financing conditions could apply for European aid procedures at the European Stability Mechanism to activate the Outright Monetary Transactions programme. Second, these same countries could find protection in the strengthening of a central fiscal capacity and in compliance with new country-specific central fiscal rules. The selection of one of these alternative options would lead to designing a very different architecture for the European Union. We are instead sceptical about the statements recently made by some members of the ECB’s Governing Council on the possible utilisation of new monetary policy tools. This paper was provided by the Policy Department for Economic, Scientific and Quality of Life Policies at the request of the committee on Economic and Monetary Affairs (ECON) ahead of the Monetary Dialogue with the ECB President on 20 June 2022.