Italy and the euro area crisis: securing fiscal sustainability and financial stability

Working papers from the Economics Department of the OECD that cover the full range of the Department’s work including the economic situation, policy analysis and projections; fiscal policy, public expenditure and taxation; and structural issues including ageing, growth and productivity, migration, environment, human capital, housing, trade and investment, labour markets, regulatory reform, competition, health, and other issues.

The views expressed in these papers are those of the author(s) and do not necessarily reflect those of the OECD or of the governments of its member countries.

Italy’s policy of fiscal consolidation and growth-friendly structural reforms has substantially improved its economic
prospects, but the adverse sentiment that the country has faced in the sovereign bond market over the past years has deep
roots. It reflects lingering anxieties over the euro area’s future, as well as persistent economic and financial difficulties, in
particular the high level of public debt and low potential growth. The government has rightly aimed to halt the rise in the
public debt-to-GDP ratio and put it on a downward path. This could be achieved with either a balanced government budget
or a small fiscal surplus. While additional fiscal tightening would have negative effects on output in the short term, it would
be rewarded by faster debt reduction and lower risk of renewed financial-market reactions. In any case, the automatic
stabilisers should be allowed to work.

Concerns about fiscal sustainability and the prolonged recession have spilled over to the financial sector. Lending
conditions are tight, non-performing loans are high and rising, and capital has flowed out of Italy to the core countries of the
euro area. The Bank of Italy should continue to ensure that banks increase provisions against losses, and strengthen their
capital asset position by raising new equity from private sources, including from foreign stakeholders, by retaining earnings
and by disposing of non-core assets. Resolution of the fiscal, economic and financial crisis in Italy depends in part on action
at the euro area level. As a member of the euro area, Italy has benefited from the establishment of the European Stability
Mechanism, the announcement by the European Central Bank of the Outright Monetary Transactions scheme and the plans
for a euro-area banking union.