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plenty of italy related comment he also maintains a collection of constantly updated italy economy charts together with short text updates on a storify dedicated page italy lost in stagnation sunday august 17 2014 the italian runaway train there has been lot s of debate in the press and in academic circles over the last week or so about whether italy s latest contraction constitutes a triple dip recession or simply a continuation of what s been going on over many many years this is an interesting theoretical nicety but in fact what is happening in italy at the moment goes a lot further than problems faced by a recession dating committee the real issue that arises in the context of the euro area at the moment is a far more specific one will the ecb do qe and if it does when will it push the button and what could happen if it doesn t perhaps a case study of the italian case is worth the effort here what is likely to happen to italian debt if there is no ecb intervention soon let s take a look at the dynamics by now almost everyone and their grandad knows that italy is back in recession following the 0 2 gdp contraction in the second quarter not only did this result suggest that italy was now in a triple dip recession or a twenty year decline it also meant that gdp was back at the same level it had in 2000 when the country entered the euro currency union the problem is that italy has an appallingly low trend gdp growth rate possibly negative at this point and nothing which has happened since the financial crisis ended suggests it is going to to improve radically anytime soon in fact there are good reasons to think that growth could even deteriorate further in the first place italy s working age population is now falling and many young educated italians are leaving to work elsewhere and now not only do we have the legacy then of high debt and low growth a new problem has emerged low inflation or even deflation italy s inflation has fallen to zero the combination of low inflation and low growth means that it is the evolution of nominal gdp that really matters now nominal gdp is non inflation corrected gdp or gdp at current rather than constant prices if inflation remains low or even becomes negative then nominal gdp will hardly increase and may even continue to contract as has happened in japan the result is bound to be that the gross government debt to gdp ratio rises above the 135 6 it hit in march one of the arguments frequently advanced about how this dynamic could be turned around would be for italy to run a large primary budget surplus now the emphasis here is on large since the country has in fact run a primary surplus income expenditure before paying debt interest since the early 1990s but that hasn t stopped the weight of the debt climbing and climbing the imf in their 2013 fiscal monitor outlined a scenario in which the obligations of heavily indebted european sovereigns first stabilise and then fall to the 60 level targeted by the eu s fiscal compact by 2030 it makes assumptions regarding interest rates growth rates and related variables and computes the cyclically adjusted primary budget surplus the surplus exclusive of interest payments consistent with this scenario as they point out the heavier the debt the higher the interest rate and the slower the growth rate the larger the requisite surplus in fact they found that the average primary surplus required in the decade 2020 2030 was 5 6 for ireland 6 6 for italy 5 9 for portugal 4 0 for spain and 7 2 for greece is it plausible that italy could run an average primary surplus of 6 6 of gdp over a decade hardly in particular this implies that on average every year the government would be draining out 6 6 of gdp from domestic demand via taxation yet as i have noted many times domestic demand is precisely the weak point in the italian economy secular stagnation ageing population as eichengreen and panizzi who studied the plausibility of the imf projections conclude these are large primary surpluses there are both political and economic reasons for questioning whether they are plausible history suggests that such behaviour while not entirely unknown is exceptional on balance this analysis does not leave us optimistic that europe s crisis countries will be able to run primary budget surpluses as large and persistent as officially projected italy s situation is to some extent replicated in other countries on the periphery ireland sovereign debt to gdp 124 portugal 132 9 spain 96 8 and greece 174 1 all numbers as of march 2014 since almost all official forecasts anticipate an imminent turnaround in the debt dynamic if secular stagnation and ultra low inflation really set in this turnaround is going to be impossible to achieve and europe s leaders will need to decide what to do about it italy s debt now looks certain to climb towards 140 of gdp and beyond maybe hitting that level as early as q1 2015 meaning someone somewhere in the official sector should be able to recognize that it is not on a sustainable path the so called aqrs bank assett quality reviews are probably not going to generate too many surprises but what about doing some realistic dsa s debt sustainability analyses cases like greece and portugal are to some extent containable from an eu perspective since the economies 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 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