Will the buck stop with Italy?

Date: 06/10/05

According to the International Monetary Fund (IMF) the world economy is steaming along happily in spite of the oil price. In its World Economic Outlook, it forecasts that global growth will be a little more than 4% this year and next.

But behind the scenes, tensions are rising. The fund itself says that "global current account imbalances" - code for the unsustainable &036;700 billion (€586.4bn) US current account deficit - have increased again. But they represent no more than "a key medium-term risk to the outlook".

Respected economists such as Stephen Roach of investment bankers Morgan Stanley beg to differ. He has put the chances of a "hard landing" for the world economy, a dollar crash and global slump, at 40% in the next 18 months.

European policymakers are worried too, not least about regional threats to economic stability, in particular the Italian connection. In June, in response to calls by a senior Italian Northern League politician, Roberto Maroni, for withdrawal from the single currency, Otmar Issing, chief economist of the European Central Bank (ECB), did not mince his words. Brutally (and uncharacteristically) he described such a step as "economic suicide".

Since then, the campaign to restore the lira has quietened down; but not the worries about Italy's economic prospects (See below, right).

Since the 1960s, dollar crises have had different impacts on different EU countries. The creation of the single currency has not changed this. By removing the devaluation option for eurozone countries, the single currency may even have made the potential repercussions of a dollar crisis on some even worse. So, in the midst of this potential global and regional instability, how robust do Europe's crisis- management mechanisms appear to be?

Michael Deppler, head of the IMF's European department, is sanguine. "The decentralised monetary union does raise issues about how you respond to a crisis, about who is in charge," he says.

"My guess is that if things get really serious [which is not what the IMF expects] those people would quickly become pretty apparent."

In an international crisis the key figures would, he suggests, be the finance ministers and top officials from the Group of Seven. On the European side, the G7 includes representatives not only of France, Germany, Italy and the UK, but also from the European Commission and the ECB.

Discussions, he argues, might be a bit more complicated than during the 1970s or '80s. But, overall, Deppler says, although crisis management in the eurozone might be "a bit more messy now", he does not see any significantly greater difficulty today than previously.

Others are less sure, which brings us back to Italy. Behind the scenes, one of EU policymakers' main concerns is how they might handle a financial crisis in Italy. Italy is perceived to have taken the benefits of joining the single currency, in particular locking into lower 'German' interest rates in 1999, without making, as Germany has, the economic adjustments that the discipline of membership of the currency union requires.

Deeply disturbing for eurozone policymakers is the question of how Italy might cope with a 20-30% rise in the value of the euro, which might accompany a dollar 'hard landing'.

Today, Italy cannot, as it used to, turn to the IMF for help and financing. The fund is designed to lend to countries not currency zones. Partly for this reason, but also because its role vis à vis advanced industrial countries has become more limited since the 1970s, there must be a question mark over the value, as a restorer of confidence in the financial markets, of the IMF's "good economic housekeeping" seal of approval.

The ECB, by law, is not permitted to bail out eurozone countries (or banks) in trouble and would feel compromised if it were asked to take on the role of passing judgement on the economic policies of a eurozone country in order to help shore up confidence.

The Commission has an economic policy analysis arm and a bail out fund. But, after the saga surrounding the reform of the Stability and Growth Pact, DG Ecofin would need more resources and more credibility for it to play the role of endorsing an EU member's economic stability programme. The Commission does not command the resources needed to impress financial markets in the event a country the size of Italy hit trouble. On the evidence, stretching from Mexico a decade ago to Brazil more recently, at least &036;30 billion (€25.13bn) is needed.

Sometimes it does not take much to trigger a crisis. Italy can count itself lucky that the scandal surrounding Gov-ernor Antonio Fazio's leadership of the Bank of Italy, both bank regulator and joint competition policy overseer for banks, has coincided with relative calm on world financial markets.

Were confidence in Italy's economic policies suddenly to erode and foreign investors to start backing away, the question of where its government would turn for that combination of massive amounts of money and credibility which are the IMF stock-in-trade, is harder to answer than you might think.

• Stewart Fleming is a freelance journalist based in Brussels.

In its second World Economic Outlook for 2005, published on 21 September 2005, the International Monetary Fund (IMF) projected a robust growth rate of 4.3 percent for the world economy in 2005 and 2006. As matters of concern it listed excessive dependence of global demand on consumption, especially in the United States, the elevated level of asset prices, particularly housing, and the high and volatile price of oil. Article also looks at high-levels economists' discussions on how to avert a financial crisis in Italy.

• Primary Source

IMF: Publications: World Economic Outlook, September 2005, 'Building Institutions' http://www.imf.org/external/pubs/ft/weo/2005/02/index.htm

---