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mies are small enough for eu leaders to engage in some sort of extend and pretend via low coupons and long horizon maturities but italy s debt is simply too big to be manageable in this way so eu leaders and the ecb now face a dilemma trying to make italy comply with its eu deficit and debt obligations may well mean that the deficit comes down but in all probability the debt level will go up given the weak nominal gdp effect not complying with them opens the possibility of stimulating slightly more growth and possibly mildly stronger inflation but naturally the debt level will rise it s a sort of damned if i do and damned if i don t situation since either way the debt burden rises from the point of view of the country s political leaders though it is obvious that austerity today has costs and few visible benefits while deficit spending may bring some short term benefit at the price of hypothetical longer term debt issues it shouldn t surprise us then if they go for the latter especially since japan s political leaders have been widely applauded for doing something similar naturally since the difficulties the onset of secular stagnation will produce for heavily indebted countries with ageing and shrinking workforces are not widely understood hints that deficit objective relaxation calls are growing have not been well received everywhere during the spring the ft published details of a document jointly issued by the german and finnish finance ministries which strongly rebuked brussels for easing austerity demands citing in particular the additional flexibility given to france and spain for reducing their budgets to within eu deficit limits since 2012 the commission has substantially changed the way it assesses whether a member state has taken effective action to comply with eu budget rules the memo states the recent methodological changes imply the risk of watering down the newly strengthened rules at its implementation stage as might have been expected matteo renzi was not slow in coming forward to seek similar treatment for his country see italy request to push back budget targets dismays brussels ft april 17 according to the newspaper the country s finance minister pier carlo padoan sent a formal written request to the commission on 16 april seeking authorisation for a change in objectives citing the severe recession that set italy back in 2012 and 2013 mr padoan wrote that italy wanted to deviate temporarily from the budget targets and that because of exceptional circumstances my emphasis throughout the government had decided to accelerate the payment of arrears owed by the public to the private sector by 13bn which would increase the debt to gdp ratio in 2014 the trouble is that these temporary factors and exceptional conditions seem to arise with a predictable regularity in italy s case the country is currently aiming for a balanced structural budget in 2016 rather than 2015 as agreed with mario monti s technocrat government in 2012 a year earlier then prime minister silvio berlusconi had promised a balanced structural budget by 2013 enter mario draghi the relationship between mario draghi and matteo renzi has long been a source of speculation and gossip shortly after he came to office in february following a kind of palace revolution inside his own party whereby the incumbent prime minister enrico letta was unceremoniously defenestrated the financial times brussels correspondent even published a post on an ft blog with the rather direct title does renzi owe his job to draghi the gist of the article was an attempt to establish some sort of connection between matteo renzi s arrival in office and the the outcome of the then recent german constitutional court ruling which put into question the viability of the central bank s omt outright monetary transactions programme spiegel s hypothesis was that the driving force for some kind of unholy alliance between the two of them lay in draghi s interest in getting prime minister letta out of office before pressure from within germany about maintaining open the offer of a now legally questionable omt programme to an italy which was visibly enjoying cheaper bond yields but was manifestly not advancing with its reform programme became too strong to withstand do last week s german constitutional court ruling lambasting but failing to overturn the ecb s crisis fighting bond buying programme and matteo renzi s ousting of italy s prime minister enrico letta have anything in common in the view of many ecb critics particularly in berlin the two are not only related but one may have caused the other in the view of many german critics there has been no serious effort by the italian government be it in the fading months of mario monti s premiership or during enrico letta s foreshortened tenure to undertake major economic reforms since ecb boss mario draghi first announced he would do whatever it takes to save the euro in july 2012 the key part of the background here is that the german court ruling effectively left omt which only ever had a virtual existence and was increasingly seen as an empty bluff since it was clear no one was going to accept the conditionality side deader than that infamous dead duck karlsruhe s objection to the existing bond buying programme was that it went beyond the ecb s mandate since directly financing government debt is prohibited under maastricht and the objective of omt was to help governments finance at an affordable price since break up risk which could have offered an alternative justification for omt is for the moment off the table omt lacked definitive legal justification and in practical terms the emperor visibly had no clothes it was just a question of how long the markets needed to wake up to the fact so it was imperative to find some other justification for the initiation of a bond purchases programme should one be needed then along came deflation the important point is that if a programme of bond purchases is implemented as a form of qe it will differ from the earlier omt programme in terms of the justification offered any qe programme introduced to combat deflation would be implemented as part of an attempt to attain price stability an objective which does lie within the central bank mandate another key difference is that if qe is launched and involves bond purchases the bank will buy bonds from all countries in the monetary union according to their weight in euro area gdp which brings us to the third difference from omt there will be no conditionality attached given this it became a high risk operation and it was clear that mario draghi needed someone else at italy s helm if he wanted to be able get the germans on board with qe someone who could convince them italy would enact the required reforms enter matteo renzi now fast forward to august and we find the former mayor of florence who had surged to office on the back of promises to enact aggressive labour market reforms a battery of spending and tax cuts and significant privatizations has been strong on talking and very weak on action something which is not uncommon in italy but people had expected more they thought this time was different mario draghi s irritation with the situation was visible at the august ecb press conference when asked by one of the journalists why italy had fallen back into recession he could hardly contain himself and was unusually direct in saying a lack of structural reforms was holding the country back and hampering a return to growth the reference to renzi was evident one week later the two met in what they had obviously hoped would be a secret meeting but italy being italy the press went along for the ride while no details of what happened at this meeting have transpired it is pretty clear draghi will have used the opportunity to read his fellow countryman the riot act italy has been full of talk about some kind of troika intervention but this is most unlikely and renzi made it pretty clear in his financial times interview that he personally wouldn t be asking for one when asked why italy s reform pace seemed so slow he rejected draghi s suggestion that the eu should intervene in countries where reforms were not being implemented fast enough i agree with draghi when he says that italy needs to make reforms but how we are going to do them i will decide not the troika not the ecb not the european commission he said i will do the reforms myself because italy does not need someone else to explain what to do the problem is that with the debt dynamics we have seen above the one thing italy doesn t have at this point is time it isn t a problem of the impact of a so called debt snowball as interest rate payments send debt levels spiraling upwards if anything it s worse mario draghi can in theory contain the debt interest problem and if needs be along with it the capital repayments schedule but the problem italy has at the moment is one of the credibility of its debt of the country being able to convincingly argue its trajectory is sustainable of being able to convince the germans that if the ecb were to buy bonds these they could ever be redeemed while renzi has waxed eloquently about transforming italy buoyed on by the results of the european parliament elections he seems more concerned with pushing through electoral reform which is obviously needed but is not perhaps as pressing as the growth and debt problem leaving the suspicion that he is more interested in getting re elected than anything else indeed the fact that he needs the support of the discredited former prime minister silvio berlusconi to get the reform through with any kind of urgency see italy slips back into recession as new pm seeks berlusconi s help has lead critics of the two institutional parties to suggest the reform may be more about getting rid of newcomers like beppe grillo s five star movement than anything else see renzi slammed for coup over senate changes to date renzi s government which is almost operating outside real historical time in terms of economic issues has made little progress on the sort of reforms which might help the country recover some kind of growth like those to the judicial system and the labor market the only measure that could be considered vaguely pro growth that his government has enacted was the 80 euro bonus delivered to low wage workers hasn t boosted the economy as its proponents claimed the measure seems more cosmetic comparable with josé luis zapatero s ridiculous plan e in spain and only reinforces the impression of politicians fiddling while rome burns the business lobby confcommercio which was highly critical of the measure calculated that consumption was boosted by just 0 1 in june the first month in which the tax relief was operative in their press release they said italian families were holding back from shopping because their uncertainty about the future was stronger than the actual increase in funds in their pockets despite this prime minister renzi continues to insist that his government s economic strategy is sound and will lift the country out of crisis in a lengthy interview broadcast on la7 television following the announcement of the gdp results renzi said that his government was determined to get the economy back on track but in due course we will work better and harder but i promised to change direction not to change the universe in three months time renzi said adding that only a comic book superhero could turn around the economy in a matter of months calmly serenely we are taking this country by the hand and pulling it out of the crisis renzi told listeners the problem outside observers are having is not in seeing the complete turnaround renzi is right here this involves a long painful road but in identifying the first baby steps that are being taken and fears about mr renzi s grasp on italy s finances were fanned again last week when spending review commissioner carlo cottarelli highlighted the tensions which existed in the government over the prime minister s spending plans in a post on his blog mr cottarelli who was appointed by letta and was previously director of the fiscal affairs department at the imf said that earlier savings were already being used by parliament for other expenditure meaning that in the longer term they could not be used to reduce taxes on employment which is what they were intended for renzi normally responds to critics that all points of view are valid but 11 million italians think differently in a clear reference to what he perceives to be his electoral support but even this will eventually wane if progress is not seen to be made on the economy the ft quotes wolfango piccoli analyst at rome based think tank teneo to the following effect as prime minister matteo renzi struggles to make progress on political reform it is becoming increasingly clear that his government lacks an original and coherent plan for the economy to add insult to injury more bureaucratic delays mean that the treasury will not hit its target to raise 12bn from privatizations this year there are also concerns about the outcome of the european central bank s stress tests and asset quality review of the country s leading banks bankers point out that if an italian bank needs a bail out the state s coffers will not easily be able to support it of course here we have a mighty instrument which draghi can use to twist renzi s arm another issue is labour market reform the controversial article 18 of italy s workers statute is just a symbol and debating it is a pointless exercise renzi told state broadcaster rai 3 last week the comments came after interior minister angelino alfano who comes from the new center right ncd party called for its abolition article 18 of the 1970 workers statue is a law that forbids companies with over 15 employees from firing people without just cause the italian prime ministers reluctance to tackle the labour market issue is understandable any attempt to really change italian labour law would be deeply unpopular on the left and even among many in his own party and a direct clash with italy s unions would surely cost him votes if his plan is to hold elections after passing a new electoral law more fiddling while rome burns so which way for the ecb evidently members of the eu commission ecb governing council members and senior political leaders in berlin amsterdam or paris are neither theoreticians nor intellectuals the secular stagnation hypothesis is at this point more akin to a theoretical research strategy than a workable template for policy making and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis as the editors of a recent book on the topic put it in their introduction secular stagnation proved illusory after the great depression it may well prove to be so after the great recession it is still too early to tell uncertainty however is no excuse for inactivity m...
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