Italy in a European Context

Research in Business, Economics, and the Environment

Donatella Strangio, Giuseppe Sancetta, Donatella Strangio, Giuseppe Sancetta

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137560773
• Topic: Economia
• Subtopic: Economia ambientale

This edited collection investigates the role of Italy in pursuing the EU five targets by 2020: R&D/innovation expenditures; the energetic measures for climate change; migration; the counter actions against poverty and social exclusion. This ambitious book uses a multidisciplinary approach and original field studies to tackle this important topic.

Part I

Economic and Social Policies

1

The Italian Monetary Policy in Perspective: Lessons from Monetary History of Italy before the EMU

Mauro Rota and Donatella Strangio

1.1 Introduction

Italian monetary policy formally became independent in 1981 after the well-known “divorce” between the Bank of Italy and the Treasury. The policy then adopted the implicit goal of low inflation and at the same time moderating cyclical fluctuations of the economy (Clarida et al., 1998). It is also entrenched the idea that before the divorce, namely before 1979, Italian monetary policy had assumed the target of control of aggregate demand in both a countercyclical and pro-cyclical perspective through the management of domestic credit.

The transition from one regime to another is marked by the use of different instruments of monetary policy. If in the pre-1979 regime the instrument was domestic credit, after joining the Exchange Rate Mechanism (ERM) the main instrument became the adjustment of the short-term interest rate. This is a peculiarity of the Italian monetary policy compared to core European countries, the US, and Japan. Germany, France, and the UK after World War II used to manage the interest rate through monetary policy; by contrast, Italy relied on the management of domestic credit.

The use of monetary instruments is particularly important in times of recession and depression. The issue has become central again following the onset of the Great Recession that has affected Western economies since about 2007. Although the Great Recession represents the most critical phase of Western capitalism after World War II, European economies have not been immune to downturns and depressions during the Golden Age in the 1970s and 1980s. Italy faced its first slowdown during the Golden Age in 1964, another in 1979, and a negative growth rate in 1975. In particular, the crisis of 1964 was a completely Italian phenomenon, while those of 1975 and 1979 were linked to the international cycle and to the oil shocks that affected Western economies.

The downturns of the economic cycle, with the exception of the 1964 crisis, occurred in a more general environment of declining economic growth rates in Italy. It is well-known that after the Golden Age, economic growth in Europe decelerated because of structural reasons due to the change in the paradigm of economic growth (Crafts and O’Rourke, 2013). Beyond the structural issues, the short-term fluctuations in the economic activity are even now linked to policy decisions.

The role of monetary policy seems to have changed to the extent that it contributes to a favorable environment for economic activity through stable prices. However, stabilization of the cyclical fluctuations is likewise crucial in prompting investments. Current central banking in Europe is focused on price stability while neglecting economic cycles. Moreover, recent empirical investigations have stressed the stability of money demand in the core European countries, including Italy, and find that inflation could be predictable by country (Carstensen et al., 2009). What studies did not predict is the current economic crisis. One reason, among others, is that modern macroeconomics until 2008 neglected the lessons of history. We contribute to the better understanding of the past by studying the cyclical behavior of monetary policy and business cycles in Italy since 1960 to the start of the European Monetary Union (EMU). We do this by using the tools and methods of standard empirical macroeconomics and by adding the beneficial perspective of historical facts. The analysis is conducted with macro-data at quarterly frequencies and the traditional vector autoregressive analysis.

Different from the contributions that focus on the determinants in the long run of the demand for money, our work aims to discuss to what extent Italian monetary policy has responded to adverse economic cycles before the EMU. Moreover, we look at the reactions during the crisis. We undertake these tasks by studying the cyclical component of economic growth and of the main indicators of the monetary policy in two frameworks: a Granger-causal analysis and vector autoregressive analysis. The main result is that the effects on monetary policy in cycle fluctuations are decreasing in magnitude overtime. We also note a different reaction in the Bretton Woods era compared to the years after 1973 up to the EMU. In the first phase, monetary policy appears to react inversely to the economic cycle, that is, the behavior is anti-cyclical or countercyclical, while after 1973 the monetary policy was accommodating to the extent it followed the economic cycle. These findings reflect the institutional changes in the management of monetary policy that occurred in many European countries in the last 40 years following the changes in the economic theory. As for Italy, our study confirms both the sunset of the traditional Keynesian approach since about the early 1970s, in contrast with the widely accepted view that Keynesian policies lost consideration in the 1980s, and the insurgence of the new monetary orthodoxy based on fixed rules aimed at enhancing central bank credibility. On the other hand, we notice a declining capacity of monetary instruments to influence the real economy in the short run even in the pro-cyclical new context. The possible reasons for the diminished capacity are beyond the aims of this paper, nonetheless the literature suggests that capital mobility and the complexity of the financial structure of the modern economy are factors able to subtract degrees of freedom away from modern policy-makers.

Moreover, we relate our paper to a number of contributions to the monetary history of Italy. Our results are largely in line with those of Muscatelli and Spinelli (2000) who find evidence of a bi-directional causal link between money and income, in line with most traditional perspectives of the pass-through mechanism (Friedman and Schwartz, 1963, inter alia). On the other hand a large body of literature considers the effects of financial and monetary cycles on the real economic activity. There is consolidated evidence that the financial intermediaries have assumed a dramatic pro-cyclical behavior in the last few years (Égert and Sutherland, 2014) similar to what we find in the case of Italy after 1973. Finally, the consideration that Italian monetary policy had become less efficient in the 1980s and 1990s is more controversial. The hypothesis is considered of little credibility for the US (Boivin and Giannoni, 2002) while Milani and Treadwell (2012) confirm a limited contribution of monetary policy to explain business fluctuations.

The rest of the essay is organized as follows: Section 1.2 presents in a critical way the theoretical and historical context in which monetary policy was implemented in the years from 1960 to 1998; Section 1.3 reviews the history of monetary policy in Italy. Section 1.4 presents our quantitative analyses of the effects of monetary policy measures on the economic cycle, and Section 1.5 discusses the historiographical implications.

1.2 Italian monetary policy in the decline of economic growth

The management of monetary instruments is today aimed at maintaining low and stable inflation rates that are beneficial to economic growth. Moreover, the cyclical movements of output could be moderated or magnified by the response of monetary policy either contrasting temporary phases of recession (anti-cyclical behavior) or helping expansionary phases by providing liquidity to the real economy (accommodating behavior).¹

The responses of monetary policies varied across times according to the dominant economic theory of a certain epoch, to political and policy reasons, and to misconceptions about the functioning of the underlying economic mechanism.

History has plenty of cases of the bad management of monetary policy in the short run. The Gold Standard between the two World Wars and, partly, the Eurozone crisis after 2011 are the obvious cases. Nonetheless, we concentrate on the monetary history of Italy after 1960 up to the EMU because the Italian case provides a clear example of the changes in the behavior of monetary policy driven by the underlying tension between the adherence to agreements on European exchange rates and the concerns about the domestic targets in terms of output growth, employment and public finance sustainability. Moreover, Italy was among the more unstable economies after the fall of the Bretton Woods regime in terms of inflation rates, control of public finance, and of the capacity to absorb external shocks, such as volatility in oil prices. Finally, Italy experienced episodes of downturn in the 1963–1964 and 1974–1975 that was unusual in the European context and suffered from the dependency of the central bank on political power much more than other countries with dependent central banks, as in France in particular.

From the early 1960s until 1975, monetary policy in Italy had been subject to the needs of fiscal policy. Muscatelli and Spinelli (2001) demonstrate that by keeping low interest rates compared to inflation and by implementing a complex capital controls and credit ceilings for banks, savings were diverted from the private sector to the public budget by increasing treasury bill subscriptions. In principle the investments were depressed although we have evidence that long-run credit fostered productivity in this period (Rota, 2013). In contrast, consumption could had been supported because of the rents from government bonds and public transfers. Hence, monetary policy formally maintained the goal of acting as a countercyclical mechanism. Whether this countercyclical behavior worked through the consumption or investment channel has to be investigated. Apart from the transmission channels, monetary policy was countercyclical in line with the degrees of freedom that policy-makers had in giving primary importance to domestic conditions. However, the behavior of monetary policy falls outside the previous narrative when the first crisis after World War II occurred.

After a period of unprecedented economic growth, 1963 is considered the starting year of the interruption of the economic development in Italy (De Cecco, 2004). The investment stream of the private sector came to a halt, wages increased after unions’ claims, and inflation became higher and more volatile. Public investments in the manufacturing sector replaced the capital accumulation of the private sector following a model of allocation driven by political interests. Big plants of state owned enterprises (SOEs) in the steel and petrochemical industries were located in the Mezzogiorno, the less developed area of Italy, where accessory industries were absent, the institutional quality, was low and entrepreneurial skills were negligible. The contraction of the private investments is assumed to be the result of the deterioration of the transitory effects of the catching up to the technological frontier and of the response of economic policies to the risk of inflation and the connected capital outflows. In particular, monetary policy became restrictive by reducing the credit to the private sector, paving the way for the deceleration of capital that deepened in key manufacturing industries in the subsequen...

Table of contents

• Cover
• Title
• Part I  Economic and Social Policies
• Part II  Business and Environment
• Index