The rationale for a safe asset and fiscal capacity for the Eurozone. LEQS Paper No. 144/2019 May 2019

The only way to share common liabilities in the Eurozone is to achieve full fiscal and political union, i.e. unity of liability and control. In the pursuit of that goal, there is a need to smooth the transition, avoid unnecessary strains to macroeconomic and financial stability and lighten the burden of stabilisation policies from national sovereigns and the European Central Bank, while preserving market discipline and avoiding moral hazard. Both fiscal and monetary policy face constraints linked to the high legacy debt in some countries and the zero-lower-bound, respectively, and thus introducing Eurozone ‘safe assets’ and fiscal capacity at the centre would strengthen the transmission of monetary and fiscal policies. The paper introduces a standard Mundell-Fleming framework adapted to the features of a closed monetary union, with a two-country setting comprising a ‘core’ and a ‘periphery’ country, to evaluate the response of policy and the economy in case of symmetric and asymmetric demand and supply shocks in the current situation and following the introduction of safe bonds and fiscal capacity. Under the specified assumptions, it concludes that a safe asset and fiscal capacity, better if in combination, would remove the doom loop between banks and sovereigns, reduce the loss in output for both economies and improve the stabilisation properties of fiscal policy for both countries, and thus is welfare enhancing

Assessing Italy's Reform Challenges:What Do Growth Accounting and Structural Indicators Say?

Italy's overall GDP growth has been dismal in recent years and this poor performance has been compounded by a declining trend in labour productivity and total factor productivity growth. This paper looks into growth accounting and structural indicators and analyses Italy's performance against other European countries. We look at the evidence provided by newly available information from the Lisbon Assessment Framework (LAF) developed by the Working Group on Lisbon Methodology (LIME) attached to the Economic Policy Committee and the European Commission services (DG ECFIN). Building upon the results of existing literature, we investigate whether this new evidence is supported by data from other sources and provides fresh insight into Italy's reform process. The main message from the analysis of growth accounting and structural indicators appears to be that Italy's GDP growth significantly underperformed that of the EU15 in 2001-2007 notwithstanding progress on reforms.Productivity, Economic Growth and Aggregate Productivity, Italy

Italy is stretching budget flexibility to the limit, raising a number of issues over EU fiscal rules

Italy is currently asking Brussels for more flexibility over its new budget for structural reforms, investments and to help manage the refugee crisis. Lorenzo Codogno writes that this makes the Italian budget expansionary and, perhaps, also pro-cyclical. Moreover, it raises a number of issues on the proper interpretation of EU fiscal rules, the rules themselves, and the most appropriate fiscal stance given the state of the Italian and EU economy

Grexit remains unlikely, but time is against the Greek government

Eurozone finance ministers met on Tuesday to discuss the Greek debt crisis following the country’s ‘No’ vote in its bailout referendum on 5 July. Lorenzo Codogno writes that while a Grexit remains unlikely, the risks have clearly increased since the referendum and the financial and economic situation in Greece may further deteriorate before a solution is in sight

Brexit poses serious political ramifications for the rest of the EU

It is not obvious if the EU would lose or gain from a Brexit, writes Lorenzo Codogno. Judging from trade and investment flows, the divorce should have less of a negative impact on the rest of EU than on the UK. Some service sector businesses could potentially relocate to the EU, and the area could divert foreign direct investment from the UK. Financial market volatility, uncertainty, and loss of confidence in the EU project could pose a more immediate and severe risk. Moreover, there is a threat of serious political ramifications and a domino effect for the rest of the EU. A Brexit would bolster anti-Euro populist opposition parties, with potentially destabilising effects for the EU and the Euro Area

Greece's clean exit: politics vs economics

There seems to be a strong convergence of interests between the Greek government, the European Commission and Eurozone Member States (and the IMF): they all want a clean exit from the Third Economic Adjustment Programme for Greece. Lorenzo Codogno explains that political motivations may well collide with the need to reduce risks and favour a smooth and successful return to normality with a post-programme in place

Book review: The European Central Bank between the financial crisis and populisms by Corrado Macchiarelli, Mara Monti, Claudia Wiesner and Sebastian Diessner

In The European Central Bank between the Financial Crisis and Populisms, the authors Corrado Macchiarelli, Mara Monti, Claudia Wiesner and Sebastian Diessner unveil the problematic relationship between the European Central Bank and European politics, and especially the populist and sovereigntist threats to its legitimacy and independence. It reveals how at times the ECB has had no choice but to make difficult decisions that impinged on the responsibilities of fiscal authorities to safeguard the European project, arguably going to the very limits of its mandate. This fascinating book is essential reading for those wanting to understand the difficult relationship between unelected central bankers and elected politicians, writes Lorenzo Codogno

Italy’s referendum: Renzi’s big gamble failed. What’s next?

Following the outcome of today’s referendum, President Mattarella will do his best to avoid early elections. Any new caretaker government would easily take a full year to deliver a new electoral law and thus the baseline case remains for elections no earlier than the natural end of this parliamentary term in spring 2018, writes Lorenzo Codogno. The tail risks of Five Star Movement getting to power, a prolonged phase of political instability and/or Euro-exit remain very low probability events

You can’t get it all: Italy’s public finances

The Italian government will present its public finance projections by 10 April. Lorenzo Codogno writes that fiscal policy is expected to be strongly expansionary in 2016, but courtesy of flexibility clauses, the government will likely avoid entering into the EU’s so called ‘Excessive Deficit Procedure’ in May. He argues however that a fiscal problem looms large in 2017, while Italy’s reduction of its debt-to-GDP ratio remains fragile and subject to external shocks

The long-term economic implications of a Brexit might not be as negative as many studies suggest

The long-term economic implications of a Brexit might not be as negative as many studies suggest, writes Lorenzo Codogno. The UK government could seek more favourable solutions on trade than the default options of the WTO framework or bilateral renegotiations of all the treaties. Moreover, economic policy has a role to play in mitigating the negative consequences. The long-term economic implications may thus be overstated, but the immediate risks may instead be underestimated. Brexit would act as a catalyst and trigger a typical balance of payment crisis, with a likely deep depreciation of the GBP and potential negative spillovers in the global financial markets