I'm not sure what you could call Italy in the EZ drama. I've heard elephant in the room somewhere but I don't think it's entirely true.
I think the problem with the Italian economy is the size. And the vulnerability. And the politics. And the...you get the point.
In fact, Italy's special place in the eurozone has a chicken-and-egg element to it. Its fate is intertwined with the evolution of the crisis; but in return, Italy's position and size can also affect the markets in very drastic ways.
RGE's Italian scenario is aptly titled "Ending la Dolce Vita". There are three bogeymen in any trouble nation that no one wants to hear - political instability, stagnant growth and a large 'debt overhang'. Check. Check. And Check.
Various analyses seem to be of the opinion that Italy's vulnerability to financial market stress will be its undoing and force it to seek external assistance within the coming year time-period. The problem is in the prognosis, and it applied to all the troubled euro nations. Staying in the EZ would mean years of low growth, structural reform and balancing and other austere measures concerning wages, pensions etc.
And although Italian economic fundamentals (low growth aside) are in a better place than Spain's, their paths seem similar - as do their bond yields.
As the latest WEO Chapter 3 states, Italy's problems have been consistent with the path to Euro membership. Post 1992, for example, the debt-to-GDP ratio shot up from the 100% threshold to about 120% in the mid 90's. Of course, 1992 was also characterized by the European ERM crisis and a devaluation of the lira which set off the typical cycle - export competitiveness - inflation+inflationary expectations - rising interest rates - burden of payments.
On the road to the euro however, with the Maastricht criteria in sight, necessary fiscal measures were taken and the primary balance improved 10 percentage points during the period!
Then of course, you have the story of the crisis. Borrowing costs converged (read: lowered), maturities were extended, the primary surplus declined as most of the previous fiscal measures were temporary and eventually, capital flows flowed in from the north increasing asset prices, setting up bubbles etc etc. All this with low growth.
That's what makes Italy's public finances appealing. It's the primary surplus! For a huge economy with a massive debt burden, it's not entirely fiscal profligacy that is the undoing.
The 80's is almost symmetric and accompanied by a significant rise in the debt burden. Post 1992, growth is consistently lower but there's a bell curve of primary surpluses and the debt normalized back from 120% to a trough of about 105% in 2004. And then the crisis hits, growth zeroes out, recession strikes and debt balloons.
The patterns in Italy's numbers are lucid and can be divided into phases that is evidenced in the WEO by the decomposition of the debt changes. One would expect that in the decade from '92 to '02, the primary surpluses would have a significant negative impact while the interest rate should have a high contribution pre-1992 (because the interest-rate & inflation dynamic looks like is pretty consistent internally).
Sure enough, the decomposition is clear:
A consistent growth contribution, a dwindling primary balance (surplus) and of course, the massive interest rate burden pre-1997.
If the ECB's OMT actions aren't able to suppress bond yields, it's practically possible that Italy is forced into a bailout. Its speed of fiscal tightening under Monti has further undermined growth prospects and the pain will show up as discontent in Monti's mandate.
The technocrats in government have been brave, but they have also been forced to act with the threat of potential catastrophe looming. Nevertheless, necessary and unpopular reforms always give rise to political opposition and instability and Italy's problems in this sphere remain far from addressed.
I think the problem with the Italian economy is the size. And the vulnerability. And the politics. And the...you get the point.
In fact, Italy's special place in the eurozone has a chicken-and-egg element to it. Its fate is intertwined with the evolution of the crisis; but in return, Italy's position and size can also affect the markets in very drastic ways.
RGE's Italian scenario is aptly titled "Ending la Dolce Vita". There are three bogeymen in any trouble nation that no one wants to hear - political instability, stagnant growth and a large 'debt overhang'. Check. Check. And Check.
Various analyses seem to be of the opinion that Italy's vulnerability to financial market stress will be its undoing and force it to seek external assistance within the coming year time-period. The problem is in the prognosis, and it applied to all the troubled euro nations. Staying in the EZ would mean years of low growth, structural reform and balancing and other austere measures concerning wages, pensions etc.
And although Italian economic fundamentals (low growth aside) are in a better place than Spain's, their paths seem similar - as do their bond yields.
As the latest WEO Chapter 3 states, Italy's problems have been consistent with the path to Euro membership. Post 1992, for example, the debt-to-GDP ratio shot up from the 100% threshold to about 120% in the mid 90's. Of course, 1992 was also characterized by the European ERM crisis and a devaluation of the lira which set off the typical cycle - export competitiveness - inflation+inflationary expectations - rising interest rates - burden of payments.
On the road to the euro however, with the Maastricht criteria in sight, necessary fiscal measures were taken and the primary balance improved 10 percentage points during the period!
Then of course, you have the story of the crisis. Borrowing costs converged (read: lowered), maturities were extended, the primary surplus declined as most of the previous fiscal measures were temporary and eventually, capital flows flowed in from the north increasing asset prices, setting up bubbles etc etc. All this with low growth.
That's what makes Italy's public finances appealing. It's the primary surplus! For a huge economy with a massive debt burden, it's not entirely fiscal profligacy that is the undoing.
The 80's is almost symmetric and accompanied by a significant rise in the debt burden. Post 1992, growth is consistently lower but there's a bell curve of primary surpluses and the debt normalized back from 120% to a trough of about 105% in 2004. And then the crisis hits, growth zeroes out, recession strikes and debt balloons.
The patterns in Italy's numbers are lucid and can be divided into phases that is evidenced in the WEO by the decomposition of the debt changes. One would expect that in the decade from '92 to '02, the primary surpluses would have a significant negative impact while the interest rate should have a high contribution pre-1992 (because the interest-rate & inflation dynamic looks like is pretty consistent internally).
Sure enough, the decomposition is clear:
A consistent growth contribution, a dwindling primary balance (surplus) and of course, the massive interest rate burden pre-1997.
If the ECB's OMT actions aren't able to suppress bond yields, it's practically possible that Italy is forced into a bailout. Its speed of fiscal tightening under Monti has further undermined growth prospects and the pain will show up as discontent in Monti's mandate.
The technocrats in government have been brave, but they have also been forced to act with the threat of potential catastrophe looming. Nevertheless, necessary and unpopular reforms always give rise to political opposition and instability and Italy's problems in this sphere remain far from addressed.
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