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Guglielmo Meardi and Lorenzo Genito on the impact of the political instability in Italy on world markets

Professor Guglielmo Meardi, expert in Industrial Relations at Warwick Business School, comments on how the political crisis in Italy is affecting Europe's financial markets.

“Italy's economy has stagnated since the adoption of the Euro in 1999, in a way that has no precedents in its whole history. People's disaffection with Italian governments and the EU are therefore understandable, but the currently proposed solutions (massive tax cuts and massive benefit increases, asking for more EU solidarity and threatening to leave) are very contradictory. Whether through a new government or new elections, it is essential for stability and credibility hat political trade-offs are made clearer”.

PhD student Lorenzo Genito of Politics & International Studies discusses the potential impact that the so-called Italian populist parties could have on financial instability, depending on how they campaign with respect to the Euro in the upcoming elections.

"Though still remote, the chances of Italy leaving the euro have never been so high. Italy’s two main Eurosceptic parties, the League and 5 Star Movement, have together obtained more than half the seats in the two houses of the Italian Parliament in this year's elections. In the past, both parties have been advocating for Italy’s exit from the single currency, on the basis that the EU’s fiscal rules are too tight and have impaired the country’s economic recovery from the financial crisis. Although both parties backtracked on their previous claims and did not openly campaign to leave the single currency, the upcoming executive will most likely have the highest share of Eurosceptic figures than any other government in Italian post-war history. As the chances of Italy leaving the euro are higher than ever, what consequences would such an event have on global financial stability?

Italy has one of the Eurozone’s largest government debts, currently standing at around €2.4tr, or 133% of GDP. For comparison, Greek sovereign debt (which caused great concern during the Eurozone crisis), stands at roughly €0.34tr (at over 170% of GDP). Crucially, putting on the sides questions regarding debt sustainability, Italy’s government paper alone underpins around 10% of the guarantee (collateral) in the Eurozone’s interbank lending market, which is the key market segment where banks access short-term funding. In short, Italian government bonds are of vital importance in the provision of liquidity in the Eurozone’s financial market. Should Italy actually leave the euro, investors would likely begin a massive sell-offs of Italian government bonds, due to the lack of guarantee that Italy’s new currency would maintain its value in the future. Thus, aside from driving the cost of Italy’s public debt servicing to the roof (which, however, could in part be offset by devaluing the new currency), Italy’s exit from the euro could severely damage the Eurozone’s liquidity in financial markets. Such developments would likely lead to a sudden halt in credit, which may trigger a financial crisis. Such a financial collapse could hardly be contained by the European Central Bank, however, having exhausted most of its monetary policy tools and without sufficient resources to purchase enough Italian government debt to make any significant difference. Given the interconnections between the Eurozone and other global markets, a new Eurozone crisis could quickly spread to the US and Asia, triggering a full-blown global financial crisis".

Ashley Potter

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