One of the countries more affected by the Great Recession started in 2007 because of the subprime crisis was certainly Italy, that could observe a slump of more than 3% in its GDP. Despite this, at the beginning the situation seemed manageable and already in 2010 people were thinking that the worst period had passed. For some European countries it happened exactly like this, but not for Italy that had to deal with the sovereign debt crisis. The Italian public debt has been very high since the early 90’s, but due to the financial crisis the situation got worst and now it is about 2,400 billion euros with a debt-to-GDP ratio of 132%, the second biggest in Europe after Greece.
This dramatic increase in public liabilities is mainly due to a fall in market’s expectations about the solvency of the Italian debt. Until spring 2011 Italian bonds’ interest rate was low enough: even though the public debt was increasing every year more, Italy was still perceived by investors as a safe country. But since there, the spread between the BTP, an Italian bond with a 10 years maturity, and its German homologous Bund increased a lot, raising worries and uncertainty in the Italian and European economy. Investors started to require higher risk premia for buying Italian government bonds, that were not considered as risk-free as they were before. Because of a higher interest rate, the value of bonds fell as well, implying a decrease in banks’ assets and a higher default risk. Italian banking institutions hold an important part of government bonds and they are very sensitive to a plunge in their market price: in fact, they became weaker and less likely to fund families and companies, provoking a decrease in the level of consumption and investments. But why people started doubting about Italian government’s probability of repayment, leading to the realization of a self-fulfillment crisis prophecy? For sure it was a combination of different factors coming from both the financial crisis and the country’s economic and political situation. In the last 20 years Italian GDP growth rate has been very low comparing to the other European countries. As the governor of the Bank of Italy Ignazio Visco claimed, this is probably due to the lack of Italian companies to innovate and invest in raising productivity, that should be a necessary process to face the challenges brought by globalization. Moreover, the Italian political framework has always been characterized by a high level of instability: an inefficient system with frequent government crisis followed by abrupt changes of Prime Ministers did not have a good impact on the country’s credibility. Typically, during a recession, individuals’ risk aversion increases significantly, and this is what happened during the global financial crisis as well: due to its high public debt and the sense of uncertainty around the country, investors were willing to buy Italian government bonds only if they would have been well compensated for the major risk with a higher interest rate, otherwise they would have switched into the safer German bond.
On August 5th, 2011 the ECB sent a letter to the Italian government in which it listed a series of issues that Italy must take into consideration in drafting its future public policies to receive a financial support from the European Union. The main recommendations were about the need to stimulate the Italian growth potential, the control of the public debt and the necessary efficiency improvements in the public administration. As a proof of the delicate situation of the Italian economy, on September 20th of the same year the agency Standard & Poor cut Italy’s credit rating.
Both the Italian government and European institutions understood that stronger economic interventions were necessary. After Berlusconi’s resignation, the government chaired by the new Prime Minister Mario Monti decided to take sound measures to restore public accounts, reforming the pension system and the job market, cutting significantly the public expenditure in the country. Furthermore, in response to the sovereign debt crisis in Italy and in other European countries like Greece, Portugal and Ireland, the ECB implemented a series of policies with the aim to improve the situation. One of them was the foundation in 2012 of the European Stability Mechanism (ESM): based on the IMF model, the ESM works mainly as a guarantee fund for European countries and for banks that need to be recapitalized. Moreover, it can also buy national bonds in the secondary market on behalf of the ECB. The same goals had the creation of the Outright Monetary Transaction (OMT) and the Long Term Refinancing Operation (LTRO): while with the first the ECB announced the purchase of governments bonds, the second is more concerned about bank recapitalization. In addition, in 2015 the governor of the ECB Mario Draghi presented the “quantitative easing”, an expansionary monetary policy consisting of open market operations with a massive purchase of national financial assets.
During crisis, before the introduction of euro, Italian governments used frequently expansionary monetary policies: introducing more money in the economy led to an increase in exports, since national companies could count on a price advantage derived from its weaker currency. Adopting one single currency in Europe also implied the renunciation of using monetary policy in a direct way, a task now entrusted to the ECB, which during the decision processes must consider the different economic situations of all the eurozone countries. Nowadays, Italian government must pay attention also in practising expansionary fiscal policies: a reduction in taxes or an increase in public expenditure could be good solutions during recessions, but in doing so Italy would end up increasing its already high public debt, situation that would lead to an additional loss of credibility deriving from the incapability to respect the budget constraints established by the EU.
Given these issues, which could be other effective strategies for the government to reobtain investors’ trust? Some policies proposed by the government and the ECB have brought some positive results, but Italy seems still really involved in a negative expectations circle. The Italian Society of Financial Analysts (AIAF) underlines the need to set up structural reforms to increase reliability for the long term and reduce the public debt. In the AIAF opinion, it is necessary to reduce the high level of bureaucracy to avoid capital flights, attract investors and encourage the creation of new start-ups. To fulfil these goals, it is also essential to improve the efficiency of the Italian justice system, considering the long time that usually trials require. Moreover, it is important to keep fighting against corruption and tax evasion, that in Italy are still a very serious matter. To try to raise investors’ expectations, the AIAF suggests also to insert in the Constitution rules about the respect of the government budget constraint: a procedure such this one could make people presume that Italy really wants to put strong efforts in solving the situation.
However, ECB expansionary policies are well considered by AIAF and the governor of the Bank of Italy Ignazio Visco: in their point of view, the Italian government should seize the opportunity to continue with the structural reforms, to reverse the trend and show that investors can rely on Italy.
– Knight Laurance, What’s the matter with Italy?, BBC News, December 28th 2011
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– Nicolini Juan P., Self-fulfilling Prophecies in Sovereign Debt Market, Federal Reserve Bank of Minneapolis, 2016