Renzi’s referendum, Europe’s future

It seems apposite that Matteo Renzi’s term as Italian Prime minister should end in this way. This referendum was a surreal distraction. Italy does not need faster political decision-making. Good decisions always trump the overrated trait of ‘decisiveness’. Nor does Italy need fewer checks and balances, with the populist 5 Star movement polling at close to 30%. It is not even clear that Italy’s priority should be ‘structural reform’ – which has become shorthand for wishful thinking. Let’s not forget that Italy has higher life expectancy than the United States – does it really need US-style product and labour markets?

Italy has two interconnected problems. It is cyclically extremely weak, having been needless devastated by the Euro-crisis, and it needs banking sector consolidation. In the days when Italian governments, not the EBA or the European Commission, made the important macroeconomic decisions, Italy would have devalued, and the government would have printed money and bought up the non-performing loans. State aid is the basis of all of all banking resolutions (what is the FDIC after all?), precisely because banking crises are hugely dysfunctional private sector failures. This economic law will be confirmed if Deutsche Bank hits a wall.

If Italy had not been subject to inept and disastrous Eurozone policy-making, Italian output would be 5-10% higher.

The reality of the Eurozone is that there are no effective, urgent counter-cyclical policies in place, nor is there a coherent way to deal with a banking crisis. Renzi is a reminder that nations are not really sovereign if they cannot print money. This has gradually dawned on the Italian political elite. If European institutions functioned effectively, this would be a price worth paying. If they remain destructive, and more concerned with establishing power than exercising it well, Europe’s political future remains treacherous – domestic political elites are incentivised to rebel.

It should not be surprising that ambitious, young, national politicians get distracted by bizarre referenda – which serve only to make the population feel briefly empowered, while leaving everything unchanged.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

One Response

  1. The Author of Below Potential

    Regarding your statement: “State aid is the basis of all of all banking resolutions (what is the FDIC after all?), precisely because banking crises are hugely dysfunctional private sector failures”, I would like to make the following remarks:

    At the moment, state aid is indeed the basis for banking resolutions in the case of sufficiently large banks – but this does not have to be the case (and should not be the case).

    The reason why government bailouts are the rule today is that the failure of a sufficiently large bank (or several banks) may well cause a massive negative shock to aggregate demand that cannot be offset by conventional monetary policy (i.e. by cutting the nominal safe interest rate). The economic cost associated with such an outcome may well be deemed too high to be politically acceptable.

    But the important thing to realise is this: while there is obviously a limit to reductions in nominal interest rates, there is no limit to the extent to which the central bank can increase the money supply. That was Milton Friedman’s point when he complained about the failure of US monetary policy in the 1930s. Of course, it is not enough to just increase the money supply. In order for the expansion of the money supply to increase aggregate demand, markets have to believe the increase of the money supply will be permanent. In short: the central bank has to commit to temporarily higher inflation (NGDP growth) in the future.

    The problem is that at the moment central banks across the world have a fixed inflation target, which cuts off this Friedmanite money expansion route to boosting aggregate demand at the zero lower bound. Hence, the central bank’s power to offset negative aggregate demand shocks caused by the failure of sufficiently large banks is limited by the zero lower bound.

    However, if the central bank had the right monetary policy regime (enabling it to commit to higher inflation in the future), the “too-important-to-fail”-problem would be solved because there would be no longer any aggregate demand shock too big to be offset by the central bank.


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