The Optimistic Case for Italy

Antonio Fatás does his best to paint an optimistic picture for Italy:

Italy: not good but we have seen this before, by Antonio Fatás: It is hard to find much optimism by looking at the Italian economy today:... I will do my best to be a contrarian and argue that maybe it is not as bad as it looks. Or maybe it is, but ... there is some hope. ...

Below is the Italian government debt expressed as % of GDP. There are two lines, the gross and net values of government debt. Net debt is a more appropriate measure as it ... is equivalent to what is referred to in the US as "government debt held by the public". ...

...If we focus on net debt the current level of debt is significantly below what it was in 1994. So Italy has seen similar or higher levels of debt before.

We can then argue that those times were different, that Italy had its own currency (although it was heading towards the Euro) and that a combination of high inflation and fast growth allowed them to stabilize that high level of debt.

Certainly it was not growth that saved them. GDP growth in Italy has been low during this period of time..., clearly below the growth in other Euro countries... What about interest rates? Maybe the government of Italy did not face the high interest rates that they face today? Below is a chart of the 10-year interest rate for Italian government bonds.

As it is clear from the chart, financial conditions back in 1994-1995 were extremely difficult for the Italian government with nominal interest rates as high as 12%. Much higher than the current levels of 6-7% that look unsustainable. Of course, what matters is not nominal rates but real rates (what really matters is the difference between interest rates and growth but I do not have that chart ready in my computer). Below is a chart with real rates that confirms that interest rates today remain low compared to the ones faced by Italy in 1994-95.

Here is what I learn... To my surprise, and the surprise of many, Italy has managed to sustain a very high level of debt even when facing high interest rates by generating large enough primary surpluses. And it has done so with a political environment that has been volatile and in some cases driven by very poor choices. Does it mean that they can keep going like this forever? No... But ... it is interesting to see when we look back at history that a similar episode did not automatically lead to default even with poor economic policy choices. And if you want to be even more optimistic, there is some hope that this crisis is not wasted and the future Italian government finds an even better way to manage a very difficult situation.