In November 2011, with yields on 10-year debt securities at more than 7%, things were looking very bad for Italy. The country was trapped in a kind of bad equilibrium characterized by low output, high levels of debt ratios and rising interest rates, three elements which reinforce each other in a self-fulfilling mechanism. Italian problems, however, find their origins well in the past. Over the 1980s and the first half of the 1990s, the public debt ratio moved from below 75% of GDP to more than 120%, while the deficit ratio was on average above 10% each year. The primary balance was constantly negative during the 1980s, signalling poor efforts or willingness from the government to control its public finances. The process towards the adoption of the euro was undoubtedly a positive shock. Since the beginning of the 1990s the primary balance turned positive, and the deficit and debt ratios started to moderate in the second half of that decade. Yet, after adopting the euro, a sense of complacency emerged. The convergence of interest rates towards German levels reduced the efforts of the government to continue on consolidating public finances and reforming the economy. This, together with the economic and financial crisis that started 5 years ago, led the debt ratio to rise again; in 2013 it was above 130%.
High levels of debt represent a drag on growth as they force governments to devote resources to pay interests on past debt rather than using resources on more productive and growth oriented investments. The debt burden and the need of refinancing it throughout the market exposes Italy to changes in market sentiments. High and rising interest rates push higher the level of debt, crowding out private investment, depressing, potentially, activity. A sluggish output pushes higher, in a vicious cycle, the debt ratio.
BY Clemente DE LUCIA
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