Even though it has not yet taken office, the new Italian government is already sending pretty heavy shock-waves right across Europe. The government programme of the Five Star Movement (M5S) and the Lega is no less than a political declaration of war on the austerity policy insisted on, to date, by Brussels. Where, up to now, the watchword “saving and reforming“ has been regarded as the panacea when it comes to surmounting crises or preventing fresh ones from erupting, Rome is now bent on doing precisely the opposite in future. The populist government is intent on setting a self-sustaining upswing in motion by boosting expenditure considerably and by rolling back the reforms which were put in place by its predecessors. Experience since the world financial crisis of the 19th century shows that such ideas are not necessarily wrong conceptually, but that all depends on when they are implemented, how sizeable they are and what external circumstances look like at the time. Given that the economic constellation in the whole of Europe is decidedly favourable at the moment, the plans of the incoming government in Rome undoubtedly fly in the face of reason.
All the same, it is hardly likely that political decision-makers on the Tiber will come round to recognising the folly of their approach any time soon. There is rather a threat of a political trial of strength between Italy and the remainder of the eurozone reminiscent of the initial stages of Greece’s Syriza administration in 2015. However, the Italian government’s starting hand for the forthcoming game of poker looks to be incomparably better than that of its Greek counterparts three years ago. Back then, the remaining eurozone states could risk countenancing a scenario which would ultimately have seen the Hellenic Republic leaving the EMU; but all the euro area’s governments will wish to avoid the question of a possible Italexit like the plague. Italy is too large and too closely financially interwoven with the rest of the eurozone for any EMU government to seriously consider an exit option. Knowing that it is holding such an ace, Italy can tread the Brussels stage with a quite different degree of self-confidence, even going on the counter-attack by demanding reforms of the EU Treaties, including the fiscal rules.
Despite this, Brussels, Berlin and Paris would be ill advised to capitulate to Italy’s demands without more ado. For that could prompt other EMU member states to follow the Italian example by demanding that fiscal targets should be loosened – were that to be the case, a transfer union could scarcely be averted in the longer run. Those holding the reins of government in core Europe should rather put their faith in the disciplinary function of the market along the following lines: if the market gradually lost confidence in Italy, the government in Rome would surely come to its senses and submit its plans to a reality check. But such a strategy would nevertheless be tantamount to playing with fire. For the market to put pressure on Italy, risk premiums would have to rise quite some way further. Yet it is only possible to a limited extent to predict the precise momentum of future market movements. Were risk premiums to spike too rapidly, the situation could quickly spin out of control – speculation about a threat of Italy becoming insolvent might well be the outcome. The problem here is as follows: once the market has lost confidence in the solvency of an issuer, trust is all the more difficult to restore. The ultimate political test would come when the currency union had to put its cards on the table and decide whether the EMU were prepared (if the ECB were not willing to mobilise its OMT programme) to ride to Italy’s financial rescue in order to prevent the country from defaulting. It is true that financial assistance of this kind could be linked to conditions, as has already been the case under the roof of the ESM. However, the price to be paid for this – and not only in a pecuniary sense either – would dwarf anything which has been witnessed up to now in the EMU. At the end of the day, there would be a real danger of the European Monetary Union being torn apart.