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Italy’s Narrow Path to Recovery

Given the constraints imposed by its huge public debt, Italy must continue to consolidate its public finances. But policymakers can, and must, support stable and inclusive growth – through structural reforms, targeted investments, and direct support for the most vulnerable sections of the population.

TRENTO – Italy faces a double economic crisis in which two recessions and a banking crisis over the past decade have come on top of a slow structural decline in growth over a far longer period. And the country’s high level of public debt leaves policymakers with limited options.

The public debt is now an astronomical €2.3 trillion ($2.6 trillion), or 131% of GDP, requiring the authorities to issue more than €400 billion per year of government bonds. This makes Italy’s economy extremely vulnerable to external shocks, and means careful public-finance management is crucial for maintaining market confidence. Investor sentiment can change suddenly – as in the fall of 2011, when the spread between the yields on Italian bonds and German Bunds reached a peak of 575 basis points. Sucked into the vortex of a serious financial crisis, Italy could not avoid a severe recession.

Here, the fundamental issue of reputation comes into play. As with people, a country’s credibility can be destroyed in a few weeks and may take years to recover. And the markets are ready to present Italy with the bill, as we saw in the summer of 2018 when the new coalition government of the Five Star Movement (M5S) and the League party announced its spending plans.

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