The Basic Flaw In The EU Fiscal Position: The Case Of Italy Today
Having survived the 2012 EU debt crisis, bond traders are now focussed on the looming crisis in Italy as that country’s government is prepared to run large fiscal deficits. There are mounting fears for the country’s financial well-being, and, more importantly, for the potential spill-over effects onto its European neighbors.
At the heart of this issue is Italy’s new populist government’s intention to increase the level of public debt which already stands at 130 percent of GDP. Italy's ruling coalition yesterday decided to boost the country's 2019 deficit to 2.4% of GDP, compared to Brussel’s demand for a deficit no greater than 2.0%. The bond market immediately punished the Rome government today as the 10yr Italian bond soared by 36pbs.
We witnessed similar developments in the 2012 crisis, especially in Greece when that government lost control over its fiscal policy. The Italian crisis is a prime example of the basic flaw in the European Monetary Union (EMU). The European Central Bank runs monetary policy, but individual countries run their own fiscal policy. When individual nations joined the EMU, they essentially adopted a foreign currency—the euro—but kept the responsibility for their own fiscal policy. There is simply no central governmental authority within the EU to manage and coordinate fiscal and monetary policies as exists in the U.S., U.K, Australia or Canada.
Italy continues to experience low growth and high unemployment. As political pressures build, it is inevitable that budgets will run deep into the red. Consequently, financial markets will tack on a higher risk premium on sovereign debt and that is precisely what we are seeing today. Unlike Greece, the majority of Italian debt is held domestically, however, that puts great pressure on the Italian banking system. The Italian bank shares index fell as much as 5% today. At this moment, it is not clear how much of this current Italian debt crisis will spread to other financial markets in neighboring countries. Nonetheless, the EU members are very concerned that these soaring debt yields do not result in a repeat of the 2012 crisis. After all, the Italian economy is nearly ten times larger than that of Greece and we recall how much havoc the Greek fiscal crisis caused the EU members.
The euro is the wrong currency for Italy and has been from the beginning. Many thousand SMEs that relied on the ever depreciating lire went out of business. One can argue endlessly about the wrongs of that but it employed a lot of people whose lives have since been destroyed. Many have left the country to seek work and new lives elsewhere. They are among the best and will not return. Italy cannot recover. Tensions within also suggest it will break-up. Sud Tyrol wants to become part of Austria and other parts of the north want independence from Rome. The EU cannot fix this and is in danger of breaking up too unless it faces up to the reality that the euro is unfixable without a banking union among other things.
How can a currency be "wrong" fora country? Any country can make their currency anything they want it to be. They just need to value it appropriately relative to other currencies, unless they want to force fixed currency conversation rates which some countries have been known to do.
Alexis, Italy is in a currency union - it cannot change the value of the euro. They could and did often when they had their own currency, the lire. James
Good question. A nation that has its own currency has the ability to set monetary policy that fits the sovereign nation. Italy and many Eurozone nations have given up that sovereignty, so that it is too strong a currency for them. Yet it is a weak currency for Germany which gives Germany an unfair world advantage.
A country needs an adjustment mechanism to allow for changes in its competitive positions. The fact that Italy cannot use i the Euro to bear the brunt of its lost competitiveness it must adjust by a drop in wages and incomes of all types. it is not the fault of the Euro but the uncompetitiveness of the Italian economy that has driven the best to leave the country.
My point is that Italy cannot run an independent fiscal policy in the interest of promoting growth.because it must adhere to deficit limits imposed by the EU.
That is the view of the elitists that have made sacrifices of humans on the sacred alter of their ill-considered euro. They call it an internal devaluation and a necessary adjustment. I have no sympathy for the use of devaluing a currency to make products competitive. I managed German companies when we had the ever appreciating DM and had to compete against that Italian nuisance. However that kept whole communities alive and tens of thousands employed. The Italian industry confederation estimated that some 32,000 companies went out of business as a result of the euro. There are humanity and ethical matters being completely overridden by this EU blindness. The euro was the direct cause of this foul consequence.
Making an economy competitive takes years, it cannot be done overnight and it cannot be done by undemocratic bureaucrats in Brussels. It has to be done by the people - if they want it to be done. Likewise decisions on which currency they wish to have.
My other point is that Italy will likely break-up anyway exacerbated by these strains.
Seems like Italy will defend its sovereignty by leaving the Eurozone rather than allow serious efforts at breaking up Italy itself!
Maybe but those tensions within that I mentioned are very real. Many companies in Sud Tyrol have moved their operations over the border into Austria to get away from the corrupt, stifling Italian bureaucracy. Their employees simply commute to and fro to work daily. The League that is part of the coalition has long wanted to separate from Italy. Many parts of the north, that is their base, still have very successful companies and that and the culture is different from the south.
2.4 percent does not seem excessive.The EU is the opposite of Trump. Trump spends too much and taxes too little. EU is too austere.
For the time being they will just suffer higher rates and debates over their fiscal policies that hopefully will teach them to get in line. If not, they are indeed headed the way of Greece and the EU needs to do something before everyone plays the fiscally irresponsible bail out game. It is unfair to the rest of the EU.