Impact of Italy’s Draft Budget on Growth and Fiscal Solvency

Olivier Blanchard, Alvaro Leandro, Silvia Merler () and Jeromin Zettelmeyer ()

No PB18-24, Policy Briefs from Peterson Institute for International Economics

Abstract: A bitter standoff is under way between Italy’s new government and the European Commission over the Commission’s objections to Italy’s proposed expansionary budget for 2019. In this Policy Brief, the authors look at the merits of fiscal expansion, concluding that Italy’s budget is unlikely to stimulate growth and may well depress it. But they argue that the budget is not likely to have a dramatic impact on fiscal solvency. Absent a significant recession, Italy’s debt-to-GDP ratio of over 130 percent will be roughly unchanged in the next few years. To reduce its debt-to-GDP ratio, Italy will need to offset its fiscal expansion eventually, an adjustment that seems feasible. The analysis in this Policy Brief has two main policy implications. First, Italy would have fared better with a roughly fiscally neutral budget, which would have led to lower interest rates and probably to higher growth and employment while still allowing the government to pursue some of its social objectives. Second, even if the government decides to stick to its deficit plan, a crisis is not a foregone conclusion. At current government bond spreads, and in the absence of additional shocks to output, the government can probably achieve some of its goals and maintain debt sustainability. But further doubts, triggered by unrealistic claims or budgetary slippages, could lead to unmanageable spreads and a serious crisis, including involuntary exit from the eurozone.

Date: 2018-11
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