Italy economic, fiscal and monetary policy

Italy’s Economic Policy

In the past seven years, the focal point of the Italian economic policies has been to mitigate the effects of the financial crisis. Two main austerity packages have been introduced since the crisis started in 2007. Both packages aimed at reducing the country’s soaring public debt and government deficit. 

Regarding structural reforms, few changes have been made over the years. The government has sought to reform public administration and public education in an attempt to improve the competitiveness of its human capital. However, the investment climate remains poor mainly due to its rigid labor laws, high labor cost, inefficient public service and the judicial system. 

Italy’s new Prime Minister Matteo Renzi took office in March 2014 and promised to revive the economy by passing one reform each month in the first 100 days of his term. In a bid to boost growth, he proposed a cut in the income tax with a cost to the government of around EUR 10 billion. The PM also announced a broad labor reform that aims at changing Italy’s unemployment welfare scheme, reforming job contracts and improving job agencies. However, Renzi’s key reform was the transformation of the Senate into a non-elected chamber, putting an end to the country’s two-chamber system. The PM also pledged changes in the judiciary system, public administration and electoral law. 

Italy’s Fiscal Policy

Following the crisis years, the Italian economy underwent a sizable fiscal adjustment. The country exited the EU’s Excessive Deficit Procedure in 2012, when its deficit fell to 3.0% of GDP. Italy has to keep its deficit below the threshold ceiling of 3.0% as this is one of the EU convergence criteria, also known as Maastricht criteria. The 2013 figure followed an average deficit of 4.6% that was recorded in the three preceding years. However, the primary balance has registered only one deficit since 1995, and that was in 2009. In 2012, the country reached a primary surplus of 2.5% of GDP—one of the highest surpluses in the Euro area. The high positive balance was key to improving public confidence. 

Despite the fiscal adjustment, which put the fiscal balance on track, the government debt as percent of GDP has been above 100% since 1991 and has been on upward trend since 2004. In 2013, government debt stood at 132.6% of GDP, which represented the second-largest public debt among Eurozone countries and the fifth largest worldwide. Doubts about Italy’s debt sustainability triggered the downgrade of the country’s debt rating over the past three years by all three rating agencies: Standard and Poor’s, Moody’s and Fitch. Sovereign debt risk premium surged to record high levels in November 2011. However, in September 2012 it started to moderate after the European Central Bank’s (ECB) announcement of the Outright Monetary Transactions (OTM) scheme. More recently, the European Union has urged the Italian government to advance with economic and structural reforms due to the excessive macroeconomic imbalances of the country. 

Italy’s Monetary Policy

At the beginning of the 1980s, the Central Bank of Italy raised its interest rate to a record high of 19.0% in order to fight the high rate of inflation. After this policy adjustment, which is seen as a “milestone” in the evolution of monetary policy in the country, the inflation rate decreased constantly. More decisive monetary policies that were conducted in the 1990s brought the inflation rate down further. In 1998, the rate fell to 1.8%. 

The Central Bank of Italy is completely separated from the influences of the government and has to comply with the rules dictated by the ECB, which are the same for all the member countries of the union. The main aim of these rules is to protect the common currency. 

The Bank of Italy, as part of the Eurosystem, helps to draft the monetary policy for the Euro area. The primary objective of the Eurosystem is price stability. To achieve price stability, the European Central Bank controls short-term interest rates. Changes in interest rates accommodate the financial needs of the banking system. 

Lately, in June 2014, the ECB reduced the official interest rate and introduced a negative deposit rate. The impact of these monetary-policy decisions in the Italian economy is expected to be observed in the short term. 

Italy’s Exchange Rate Policy

The lira was Italy’s currency from 1861 until 2002, when the country officially introduced the euro. In 1979, Italy became part of the Exchange Rate Mechanism (ERM)—a system which links the currencies of most of the European Economic Community (EEC) nations. In order to prevent big fluctuations relative to the other EEC countries, Italy had to maintain its exchange rate stable within threshold bands of +/-2.25%. However, in 1992, Italy had to devalue the Italian lira by 7.0% and as a result entered into a system where the fluctuation bands was wider. 

Nowadays, the Bank of Italy, as part of the Eurosystem, participates in foreign exchange market interventions along with the ECB and the other National Central Bank of Eurozone. 

The Bank conducts foreign exchange operations to keep its foreign currency reserves under control. In order to balance inflows and outflows of foreign currency without changing the composition of foreign currency reserves, the Bank of Italy buys or sells foreign currency with market counterparties.