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Finally, Berlusconi's Departing -- But That Won't Help the Eurocrisis Unless Austerity Plans Exit, Too

Berlusconi’s exit –though welcome -- will not solve Italy’s problems. Forced austerity measures are preventing investment in precisely the areas needed for recovery.

What exactly is the eurozone crisis? Is it a financial crisis? An economic crisis? Actually, it’s a growth crisis. And as such, it must have growth solutions. Instead we are being bombarded every day with theatrical new developments (Papandreou’s referendum, Berlusconi’s wavering on reform and elections) that would make us think that it is all the fault of some corrupt and/or lazy politicians. Or the result of Europeans, and their governments, refusing to live within their means. The solution, we are told, is better politicians and belt-tightening.

We are told, for example, that Italy’s enormous debt (118% of GDP), has caused the “markets” to doubt the country’s ability to pay it back, causing the interest it pays on its bonds (the way it funds its debt) to rise to an unsustainable level (7% on November 9 th). That rate, we hear, brings Italy to the ‘tipping point’ of default, and will cause it to exit the euro. Pundits claim that in order to “save” Italy, almost all the funds in the European Financial Stability Facility (EFSF) would need to be used (1 trillion euros). That figure is so big that it is deemed not only “too big to fail,” but also ‘”too big to bail out.”

Wrong-headed Responses

The problem is that the ESFS is not a central bank. So it can’t really calm markets that want to know that there is a lender of last resort that will insure against defaults and hence prevent the type of bank runs we used to see in the early part of the 20 th century. The main weapon to combat the crisis should have been the European Central Bank’s (ECB) monetary policy, i.e. the ability to affect the money supply through changes in the interest rate and buying of national bonds (quantitative easing), as it is starting to do now. Unfortunately, it’s much too late because the contagion has already happened.

The Germans fear of inflation, but that is foolish because quantitative easing does not lead to inflation when there is massive underutilized capacity in the European Union. Their general feeling that the weak countries must sort themselves out has prevented the ECB from acting like a central bank. Which makes everything worse than it had to be.

Here's the rub: Even if the ‘bailout’ plan for Greece, Italy, and whoever is next worked (i.e. let’s forget for a moment the too big to bail problem), the real issue is the so-called “PIIGS” countries (Portugal, Ireland, Italy, and Spain) and whether the austerity plans being shoved down their throats will help them. Or make them worse? Let’s concentrate on Italy.  

The Truth About Italy

We are told that Italians have been living beyond their means, in the lala land of La Dolce Vita. This could not be farther from the truth. Most Italians have very high savings rates (the highest in Europe) and have very little debt (e.g. most Italians own their own homes with little mortgages). And the public debt is mainly owned by Italian citizens, who happen to be quite risk-averse and hence invest in bonds. This means that the public debt is offset by private assets. Thus, the country as a whole is relatively solvent.

It is also not true that Italy spends too much. In fact, the Italian government has often spent less than its income, i.e. what it brings in via taxes—even with all the tax evasion! Not only is its deficit relatively normal (4%) but the reason its debt has been rising is not due to spending, but simply due to the very high interest that it has been paying on its accumulated deficit, i.e. its debt. And as long as the interest it pays on its debt (currently the astronomical 7% but even before quite high) is higher than the rate at which its economic output grows, then its debt/GDP ratio will continue to rise.

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