” Italy has another crisis – but it has nothing to do with us”: This is the almost unanimous tenor of many discussions on the dramatic political developments in Italy in recent weeks. But is this assessment right or is Germany at least partly to blame?
The truth is: Italian politics are chaotic and cause for concern. Initially, the Five-Star Movement and Lega government program envisaged a large budget deficit – estimates suggest a budget hole of € 100 billion to € 125 billion – and included clauses stating the possible introduction of a parallel currency and exit mechanisms from the monetary union .
President Sergio Mattarella stopped the formation of the government and rejected the proposed finance minister Paolo Savona because of his Euroscepticism . The financial markets responded mercilessly: the rise in interest rates on Italian government bonds surpassed everything Italy had seen in one day, even during the eurozone crisis of 2011 and 2012. The horror of this financial market reaction was deep. Within just three days, a new Five Star Movement and Lega government was deployed. The controversial Savona will now be Minister for European Affairs instead of Minister of Finance. Whether this is better for the European project is an open question.
Although the government in Rome does not seem to think about leaving the euro anymore. But the new Cabinet makes the fundamental problem of the euro zone again obvious: The German government and its counterpart in Italy have completely different ideas about how the monetary union should work. The crux of the problem is that Germany has a tradition of a hard currency, while Italy has always relied on a soft monetary policy.
Until the introduction of the euro, the Italian political system solved domestic distribution problems mostly by borrowing from the state and by financing the high budget deficits through devaluation and higher inflation . The now foreseeable rise in Italian deficits follows on from this soft currency policy. He will inevitably aggravate the conflicts with Germany, which is proud of its stable and strong Mark’s past.
Since the beginning of monetary union, Italy has had overall control over its budget deficits, but debt has continued to rise over the past ten years. As economic growth failed to materialize at the same time, the debt ratio – ie the total national debt relative to economic output – increased significantly. If there is neither growth nor the possibility to distribute money by deficit, the distribution problems in such a zero-sum game are exacerbated.
But the new government now wants to increase spending, lower taxes and thus significantly expand the state’s deficit. Italy can finance a higher level of new debt, but only for a limited time. The plans, however, seem to be aimed at a long-term change. They thus become a serious problem for the sustainability of public debt. Such a debt would be possible with a soft monetary policy – but such a deciding no longer a national leadership, but the European Central Bank (ECB). A conflict with Germany and the ECB would be guaranteed.
What options are the Federal Government now to solve this dilemma? One possibility would be to do nothing and hope that Italy would comply with European treaties. The financial markets are likely to react negatively to a larger structural deficit in Italy: interest rates are rising, and Italy will be forced to reverse the trend.
The populists, however, will know how to use this situation for themselves, and Euroscepticism in Italy should then continue to grow. Even now, the populists in the new government are sharply opposed to the “dictates of the financial markets” as well as to Brussels , Berlin and Paris. In addition, the underlying problems in Italy, such as high youth unemployment, would persist. The next election could then lead to even more extreme results.
The alternative would be to approach Italy’s new government and work on constructive solutions. As Angela Merkel has hinted in her recent interview, she seems to want to pursue this line. A first starting point would be a common migration policy. The issue of immigration has been central to the Italian election campaign, and Italy has taken on huge burdens in recent years and deserves European solidarity. The idea of the European Commission to equip the border management authority Frontex with up to 10,000 employees is therefore a step in the right direction. It would also be possible to use the new Structural Reform Fund more actively in Italy. For example, it would be possible to support the dissemination of e-government – an effective means of combating corruption – with EU budgetary resources.
While these steps are important for EU cohesion, they can not resolve the conflict between the concepts of hard and soft currency policies. In the long term, Italy will have to end its debt policy and implement reforms to strengthen its own economy. However, this will only be politically viable if Germany accepts that the single currency needs inflation of two percent. The enormous economic difficulties in Italy have also been linked to low inflation, which has driven up Italy’s real debt burden.
In recent years, the inflation rate in the euro area was even below the levels at the time of the Bundesbank. For Italy, inflation is too low. In order to reach an acceptable level for the Eurozone , Germany will have to increase its demand and thus increase inflation, so that Italy can breathe economically again. Unfortunately, the Chancellor did not mention this point.
Both sides will have to move towards each other: Germany will have to take a step, but Italy has to make a giant move. The government in Rome has to refrain from the idea of an incalculable fiscal straw fire. However, looking for the guilty only in the other country will not solve the problem, but will lead to the end of the Eurozone.
-GUNTRAM B. WOLFF