Buying time for Italy

Buying time can be useful if you get something useful with it, otherwise it is a waste of time and money. Italy needs to borrow less domestically to finance its government’s expenditures (reduce its fiscal deficit) and to borrow less abroad to finance its imports in excess of its exports (reduce its trade deficit). The lower interest cost of the IMF and/or EU lending money to the governments of Italy and Spain at German sovereign debt interest rates can buy them time to enact and implement government spending cuts, tax increases, and market reforms that improve productivity and reduce labor costs before they need to borrow in the market at potentially much higher interest rates. Why might the IMF and the EU’s European Financial Stability Facility (EFSF) be willing to lend money at German rates when market investors aren’t? That is a good question without a clear answer, though most commentators seem to assume it without much question.

The pay off from the measures Italy needs to implement will take time to materialize. Liberalizing markets takes years to actually improve productivity and exports. Some domestic wage and price deflation will probably be needed as well. Reforms to the tax system take time to produce revenue. Above all it will be difficult for the Italian economy to grow (the essential ingredient of financial sustainability) while the rest of Europe, if not the world, is stagnating. In the interim, Italy’s deficits will remain above the levels expected to result from current reforms in the future (say two to four years down the line). If they cannot be financed at “reasonable” interest rates, Italy will be forced to default on its fiscal debt of about 2 trillion U.S. dollars (of which about $500 billion falls due and needs to be refinanced in 2012). The impact on the banks, pension funds, and others that hold this debt would be devastating beyond our experience.

Thus IMF et al financing can be useful if a) Italy actually enacts and implements now the reforms needed to become viable in the future, and b) if the IMF is more confident that Italy will achieve the desired outcome than are market lenders. Without condition “a”, buying time is a waste of time because Italy would default anyway only somewhat later after running up even more debt. With regard to “b”, it may be that the IMF is better able to assess and enforce Italy’s reforms than the market (the IMF reviews progress every quarter against agreed performance criteria before authorizing the next quarterly tranche of its loan), but it is not obvious that this is so. Market lenders can see any reforms actually undertaken and the result almost as easily as the IMF can. If these measures are credible and convincing, market lenders will reduce their risk premiums for lending to Italy. If so, no funds from the IMF would be needed.

On the other hand, lenders may have become risk averse in the conditions now existing in Europe and the U.S. and world economy. If so, they will demand an interest rate to lend to Italy that is more than the premium needed to cover the expected loss from default. In these conditions IMF/EU financing could make the difference between success or failure. Undermining confidence in the ECB and the purchasing power of the Euro would be bad under all scenarios. While more rapid growth in the supply of Euros as the result of ECB purchases of Italian and Spanish debt might not be expected to be inflationary in today’s depressed economies, the effect on Euro interest rates will depend heavily on public confidence in the ECB’s anti-inflation commitment (i.e. inflationary expectation. See my earlier note on the role of the ECB:



Here are some interesting comments from friends on my earlier note on the use of the ECB to buy Italian debt.

Thanks Warren, it is hard to be optimistic that the politicians and technocrats of Europe will stumble on the only thing that will work.

Thought experiments: why do we never see calls for “break up of the $ zone” such as when Puerto Rico got into fiscal troubles (see Stossel and Cal Thomas or recent reforms)?  Why don’t El Salvador, Ecuador and Caribbean Islands “leave the $ zone” so they can devalue to prosperity?  So far, we have a credible “no bailout policy” so even Harrisburg must go into bankruptcy.  In the US $ zone, counter-party risk is still important.

What if: instead of a “euro zone” we had seen 16 countries in the EU unilaterally adopt the DM?  The Frankfurt-managed currency would have appreciated sharply in recent years compared to the US $, much like the C$, Aus$, et. al.  The adopting countries would then have been in the position of Chile 1981.  When pegged to a weak US $ during the Carter years, Chile thought pegging was great.  Then, on the first Tuesday of November 1980 the US $ started to appreciate, and Chile found themselves holding the tail of a tiger until they rediscovered the virtues of floating.

If Italy and others are to stay on the “paper-gold standard” of Frankfurt, they will have to reduce real wages (& pensions etc.) the old fashioned way.  If that is too painful politically, and if Frankfurt refuses to abandon administration of “paper gold”, then Italy, et. al. must remain the Appalachia of the euro zone.

Why would Cameron want the ECB to monetize euro-zone debts?  Is it because more inflation in the euro zone as well as the US will take the pressure off the UK pound?

Jerry [Jordan, former President of the Federal Reserve Bank of Cleveland]



You make a very elegant and compelling case. But I’m not convinced that it will work. The likelihood of the ECB remaining politically independent is slight. And the only way Germany will be able to enforce the kind of austerity it’s promoting will be to invade and occupy these countries’ finance ministries (which has already begun, but without decisive popular support). Just as in the US, the people who need to bear the brunt of a recovery–the largest banks (in this case, the French banks which are the most exposed) and the bond markets–are the least likely to do it, and so hold a near monopoly on the recovery. At some point the people really bearing the brunt—the people least able to do it–may just give up: on the ECB, on the Euro, on the EU. Russia in the 1990s is a case in point. How many European Putins are there waiting in the wings? So long as the US and China and nearly every other power is dealing with this crisis publicly at the other end of a ten foot pole, I find your, and any other positive, outcome, very unlikely at the present moment. Sacred tenets of central banking aside, from where I sit this looks like little else besides beggar thy neighbor. On every level.

Ken [Weisbrode, in Boston]


Hi Warren,

I don’t have the time these days to read your lengthy blog essays, alas, but I did want to make an admittedly superficial comment or two.  I really wish somebody would actually treat a sovereign borrower like an ordinary client some time.  These Greek demonstrations are disgusting. Your country doesn’t have money, and you’re insisting that it keep the generous welfare taps wide open.  Just where is the budget supposed to get the money to pay you to shut you up?  It would be wonderful if the Greek demonstrators were given what they want, the country would default in a few days, and then the banks would take over the bankrupt estate and liquidate it.  Not that banks are such wise and nice entities, but I just feel the Greek demonstrators deserve exactly this.  It’s the logical consequence of their irrational demands.

Next topic:  I’ve never understood the phrase (one that I have translated you saying many a time, I might add) that “of course, interest rates can’t go negative, so central banks are seriously constrained in their ability to loosen the money supply once the rates are down near zero already”.  Why can’t they go negative?  If the economy is so moribund that banks aren’t lending any more, only fuelling the moribundity further (not that you can fuel moribundity…), why can’t/shouldn’t the central bank loan money to the banks at negative interest in order to kick start lending and economic activity in general?  It’s Keynesian deficit spending by other means – monetary instead of fiscal.

Just having a rare moment of economic musing, sorry to bother you with my infantile thoughts.  Hope all is well with you, and that you have a good Thanksgiving.  Nailya and I will be passing through DC in the next month or so, but literally passing.  If plans change and we end up staying a little while, I’ll let you know and perhaps we can get together for a bit of socializing.  Nailya’s gotten quite interested in economic and political affairs (she never had been in Russia, because there’s no point in getting excited about something that gets arbitrarily decided by the corrupt suits in the Kremlin without regard for anybody else), so I know she’d make a lively conversationalist.

Steve [Lang, former personal Russian/English translator for Mikhail Khodorkovsky after being the same for me and the IMF]

About wcoats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 2003 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My most recent book is One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.
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4 Responses to Buying time for Italy

  1. Joe Cobb says:

    So, from your first paragraph, I see Italy is running a trade deficit. Is the incoming foreign investment going entirely into Italy government bonds? Is there no net direct private investment? Doesn’t a trade deficit usually mean a net inflow of capital – and a good thing? I think most discussions about trade deficits are just mercantilist thinking, but in a fixed-exchange rate system like the euro, some of the blame has to go to the unproductive, overpaid workforce and to the evil politicians . The Italian government is clearly overspending or undertaxing (depending on one’s view about budget balancing).

    I agee with Jerry Jordan and Ken Lang: let them hang. If Italy cannot borrow, let them start missing payrolls and stop paying interest on bonds. If the IMF wants to help Italy, maybe it should just fund the payout at maturity of Italian bonds (after haircutting them by at least half). I appreciate the EU banking system, particularly the French, are exposed. But I don’t see what the systemic harm might be if Sarkozy had to take some special action to keep his (nationalized?) banks solvent.

  2. Mark Falcoff says:

    Warren, I am anything but an economist but I do know something about Italy. The country has never really recovered from the division in 1943-44, when the country was split into two, the bottom half occupied by the Allies, the top half by the Germans (through the curious establishment of the “Italian Social Republic” with Mussolini restored to power at its head). Since the 1946 elections (in which, be it noted, our CIA played a not insignificant role), Italy has basically coexisted with two incompatible cultures–Neo-Fascism and Communism. For years the Christian Democrats (the cleaned-up, more presentable and certainly more civilized version of Mussolini’s fascism) ran the governments, while the Communists and their allies in the smaller (but surprisingly numerous) Marxist parties ran the culture–universities, press, book publishing, and some of the electronic media. In the longer term, the latter, in my opinion, has proven far more important.
    I am not saying that the choices Italy faces today are between capitalism and communism–as such. But rather, I am saying that what might be called the Marxist sensibility, married to garden-variety populism, is the choice of at least half the Italian population. (The alternative is a kind of sanitized fascism, a la Berlisconi, with its populist flavor). In an ideological environment of this type, it is difficult for me to see Italians making rational choices about economics. In many ways what we have seen in Greece–a country which, like Italy, has never really recovered from the Second World War and its immediate aftermath–is a dress rehearsal for what we can expect. To be sure, Italy is a bigger country and a much larger economy than Greece. That makes the crisis for the ECB and the EU all the more unmanageable. As in the case of Greece, an infusion of new resources to Italy will merely postpone the inevitable. But thank you for your thoughtful analysis.

  3. It’s always a pleasure to read your posts. I posted a Sixth Report to the European Union this week myself. You can take a look if you like. This entire matter can be resolved if the EU unites under on Treasury, and one government outside of Germany. Yes, I know that the other EU countries are afraid of a takeover by Germany. If the ECB is moved to a neutral country, then this is not a threat any longer. The EU needs to develop a new constitution, rules of succession of sovereignty, and other founding documents. This can all be done reasonably and efficiently if the Lisbon Treaty is changed to allow a lower threshold for passage than 100%. Warren, as usual, my post is available at . Happy Holidays!

    Mark Winkle
    Consultant One

  4. Well sir, It will be a Merry Christmas this year after all. Thank your friends at the IMF for backing my requests to unify the European Union under one standard (flag). 26 out of 27 so far. I sent a personal letter to PM Cameron. I think that England will go along with my plan if the ECB is transformed into a Federal Reserve and moved to London, England. This provides centrality and England’s support. If the Treaty of Lisbon is modified and negotiated in good faith for the benefit of all of its citizens, a “TRUE DEMOCRACY” can rise up and create a United European States making it the third economic power in the world. The facts are there. The Sixth Report includes a link to a Eurostats report issued by the ECB showing that 10 years ago Germany was in nearly the same financial straights as Greece finds itself today. A unified Europe would benefit not only Europe but the world, if it is a True Democracy and not just another republic. The debt can be bought by a Federal Reserve that replaces the ECB. This provides many benefits as well as financial stability. I think your friends at the IMF noticed this earlier this week when they backed the financial moves that I have requested be made.
    There should be no penalty for any country not meeting the target of 3% over a balanced budget. It will take time for many countries to balance their budgets. I believe that a ten percent debt reduction is sustainable. The ECB wants major immediate reforms. This is not reasonable. My Economic Stability Formula of a Balanced Budget with an annual pay down of 10% of debt is feasible. Ms. Merkel will find that incentives will work better than forced austerity. Germany is not conquering these countries, rather it has the opportunity to make life long friends with them, or eternal enemies with them. If austerity continues to be forced upon these violating nations, they will leave the Eurozone and take their purchasing power with them.
    Less vinegar and more honey as my dearly departed mother used to say. Angela Merkel could use some honey to put a smile on her face instead of a snarl. I continue to offer my in person negotiating services, but no one over there wants a Yankee to negotiate with them. I am none too diplomatic at times. James Nash said it best I believe, “Let the figures speak for themselves.”
    I would be honored to meet you and shake your hand next year if I am invited to the signing of the New Treaty of Lisbon. The negotiations will prove interesting. My blog page at has exploded this week with over 200 plus views alone.
    BTW I started another blog at as well as a Podcast Series on ITunes. I also am contributing to over 50 newspapers regularly. Who’d of thought?
    Merry Christmas and a Happy New Year!

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