Europe's self-destructive war on Italy

Will Europe destroy itself to scold Italy?

Italy and the European Union are headed for a throwdown. Italy's new government wants to help its citizens following years of grinding economic immiseration. And the EU is hellbent on stopping them, all in the name of neoliberal budget discipline.

It's an astonishing spectacle, one that exposes the bottomless stupidity and self-destructive high-handedness of EU leadership.

Italy was hit hard by the global economic collapse of 2008 and the ensuing eurozone crisis. Italy's unemployment rate peaked at 13 percent, and after years of suffering under EU-imposed austerity measures, Italy's unemployment is still hovering around 10 percent. Not surprisingly, Italians finally got fed up with this state of affairs; in June, they revolted by electing an oddball coalition of left-wing and right-wing populists to run their government.

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That new government promptly proposed an ambitious national budget, including a guaranteed minimum income, cancellation of planned cuts to Italy's public pension system, a bevy of tax cuts, and more. Needless to say, this massive spending package, along with reductions in tax revenue, would require bigger deficits. Italy projects a gap between spending and tax revenues of 2.4 percent of GDP in 2019.

Why do this? Quite simply, the Italian government wants to cut poverty and offer its citizens some help as their economy continues to trudge along. But it's also sound macroeconomic policy: With unemployment at 10 percent and GDP falling — from almost $2.4 trillion in 2008 to $1.9 trillion today — Italy is clearly suffering from a big shortfall in aggregate demand. The way to fix that is for the government to spend more than it taxes; specifically, to spend on programs that get money into the hands of consumers. Italians would subsequently spend that extra money, which in turn would create more jobs.

The European Union's technocratic overlords are not in favor of this plan, to put it mildly.

EU rules forbid member nations from running deficits over 3 percent of GDP. That's already a foolish limitation, but Italy nonetheless falls within its bounds. The complication is this: The European Commission was given the power to vet the budgets of EU member nations in 2013. And Italy's total debt load is already around 132 percent of GDP. Furthermore, back in July, the Council of EU Ministers made a binding recommendation that Italy cut its structural deficit by 0.6 percent of GDP. (A structural deficit is the budget deficit excluding business cycle effects and other one-off events.) Instead, Italy's planned budget will raise the structural deficit by 0.8 percent of GDP.

Put it all together, and the European Commission concluded that Italy's plans are in "serious non-compliance with the budgetary policy obligations laid down in the Stability and Growth Pact." The commission wants Italy to take its budget back to the drawing board or face fines and penalties.

The Council of EU Ministers is made up of officials from EU member states — somewhat equivalent to Cabinet secretaries here in the United States. The European Commission, meanwhile, is a governing body whose members are appointed by the European Parliament. (It's the European Parliament that operates the way democratic legislative bodies generally do, with EU member nations electing their representatives.) Why, exactly, other than the existence of the byzantine rules of the EU, should these people get to tell Italy's democratically elected government to ditch its plan and impose more austerity on its citizenry?

As is often the case, the answer is money.

If the Italian government controlled its own currency, its central bank could simply buy up the government debt created by its deficits and keep interest rates down. But Italy is a member of the eurozone monetary union. And the supply of euros is controlled by the European Central Bank (ECB), which in turn oversees the national central banks in the eurozone. The ECB system has all sorts of rules and limits for when it can buy debt issued by the eurozone member nations and how much it can buy.

That leaves it to private investors to supply the Italian government with the extra euros it needs to cover its deficits. Not surprisingly, political turmoil is making them skittish, so interest rates on Italian debt are rising.

But Italy's rising interest rates are the result of arbitrary political choices either built into the structure of EU governance, or enforced by the EU's reigning technocrats. The ECB could simply instruct Italy's central bank to start supplying fresh euros and using them to buy up Italian debt, thus supporting the government's deficit spending. The only hard economic limit on that sort of policy is the inflation rate. Now, that rate is around 2 percent, which is where the ECB likes it. But for monetary aid to Italy to actually start driving up inflation, not only would unemployment in Italy have to first fall drastically, but unemployment across the entire euro currency area would have to first fall drastically.

In short, the European Union and the ECB all have enormous room to help Italy deficit-spend to repair itself, with no economic downside. They just don't want to do it.

Italy, meanwhile, looks ready to play chicken with its EU masters. "These measures are not meant to challenge Brussels or the markets, but they need to compensate the Italian people for many wrongs," Italian Deputy Prime Minister Luigi Di Maio said earlier this month. "There is no plan B because we will not retreat."

The European Commission has never actually gone so far as to reject an EU member's budget before. It has until Oct. 29 to decide whether to formally take that step. If it does, and the resulting fight wrecks the foundations of the modern European project, EU leadership will have no one but itself to blame.

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