Fragmentation Risk: What Is It and Should the ECB Care?

ABSTRACT

In 2022, the ECB introduced a new policy tool, the Transmission Protection Instrument, to reduce the risk of financial fragmentation in the euro area, following the normalization of monetary policy. This paper aims to clarify what is meant by fragmentation risk, where it comes from, how it affects the real economy and what can be done about it. We propose a typology of fragmentation risks and examine their destabilizing potential within a monetary union by means of a small macroeconomic model. We next provide empirical evidence of fragmentation risk and discuss possible policy responses. We conclude that, although the risk of fragmentation is real, ECB intervention is not the only game in town to contain it.