Italy aims to reduce deficit post EU criticism: Article Analysis

Summary of the Article

The populist government of Italy will cut its budget deficit targets from 2020. The coalition said it planned to run a deficit of 2.4% of GDP for next year and also said that the deficit would stay at that level through 2021. This announcement shaken markets and stimulated criticism from European commission. That decision made Italian government bond profits down. Italy’s leading stock exchange, Milan’s FTSE MIB, closed up 0.9% after several days of tumbling share prices. Giovanni Tria, Italy’s Minister of Economy and Finance, confirmed that the fiscal shortfall would be put on a downward path after next year. The coalition says an expansionary budget next year will boost economic growth and thereby curb Italy’s debt, at about 131% of GDP.

Analysis of the Budget Deficit

Before start analyzing the article, I will start explaining key words and concepts that have relevance during this essay.

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First of all, the budget deficit occurs when the government expenditures exceed the revenues, to increase the insufficient AG (aggregate demand) to financing need of the government who, as a consequence, will face a debt issue. Both, budget deficit and debt are terms commonly used in macro-finance. The budget deficit, as mentioned before, it occurs when the spendings are substantial than the revenue received within a year and deficit is when spending exceeds revenue. When this deficit is an accumulation of each year’s deficit it is called national debt.

In the debt issue we face two problems, the first one is the need to allocate resources to pay the interests of the debt for the next fiscal years and the second one is the increase of the ratio debt or gross domestic product that tends to be a risk premium. Gross domestic product (GDP) is the total value of goods and services produced in a country in a period, normally one year, deducting what is consumed in production, that is, the final total value. Once having said that, I begin my analysis about the budget deficit and the budgetary plan that Italy proposed.

The financial markets are anxious about the meetings in Rome for some reasons. First, after Germany and France, Italy is the third biggest economy in the eurozone, it is quite important to remember that the eurozone is the economic region by those countries of the EU that have adopted the euro as a national currency. Second, after approximately two decades where the economy has fastened a little improvement, the banking system of Italy is still weak. And one of the latest reasons, and not for that means the less important one, is that the current government chosen this year it is a new populist one, a coalition between the League and the Five Start Movement. One of their main targets is to introduce basic income and to raise the pensions. The last one is a budget expenditure in one of the three main areas, specifically transfer payments (specific in transfer payments that it is the money transferred from tax payers to benefit the pensioners).

The fact is that Italy's budget deficit decreased in 2018 to 0.8% of the country's GDP was caused by a few plans that the government acquired and according to the Italian government expectations, in 2019 it is expected to boost. The deficit is the gap between the public spending and the money raised through taxes. A constant tax rate induces the budget deficit to move one-to-one with public spending and therefore with the current account (Roubini, 1988). The new administration said that it plans to run the deficit about of 2.4% of GDP in 2019 and then a gentle decrease to 2.1% in 2020 and 1.8% by 2021.

The Italian banking system is surrounded with negative debts and that has meant its ability to provide has been incapacitated.

If monetary policy (controlled by the European Central Bank, greatly affects the AG in the short run) doesn’t work, there is an argument for fiscal policy —refers to the budgetary policy of the government, which engage the government manipulating its level of spending ad tax rates within the economy— to carry out a more important role in creation of demand. But it would be provisional instantaneous and efficiency implementation. Fiscal policy, as it is mentioned before, it means changeable in either taxes or spending, and its results can lead to optimize the efficiency of means dealing with variations or with higher frequency of those in GDP or employment as a broader concept. By using fiscal policy, to stabilize the country economy, they would have to spend more or less taxation to increase the deficit and then decrease the deficit by raising the taxation or cut spending. Larger and stronger growth should in the end lead to important fiscal revenues and a low deficit.

Not everybody sees it in that way, and that is the major problem. For example, the European Commission has a conservative approach to member states running budget deficits, and prevailed that these should not go above 3% of the gross domestic product, while Italian budget would be below that, Brussels will not agree with fiscal negligence. On the other hand, financial markets also reacted badly to the budget plans, making it more expensive for Rome to service a national debt, all the accumulated borrowing by the state down the years, standing at around 130% of GDP, this percentage varies between a 1-2% depending from which source you read it.

That also have a consequence in Italian banks, because they have been important buyers of the bonds sold by the government, and their financial position becomes shakier if those bonds go down in value. The markets are worried about a weak growth, a rising deficit, losses on bonds and failing banks. They also fear that Italy’s problems will spill over into the rest of the eurozone, since banks in other countries, most notably, France, are big holders of Italian debt.

Conclusion

It is my personal belief that, the wounding consequences that not only Italy, but all the other countries located in the eurozone are going through, must be somewhat related to this previously mentioned revolution carried out by the current Italian government. The coalition was agreed upon in Italy in June 2018 by the Five Start Movement (M5S), and the League, which is also known by the Italians under the name of Lega Nord, alongside with some other independent parties which happened to be chosen by the former and latter parties. The controversial electoral program that was signed by this populist coalition was one with a series of measures regarding a listing of topics such as the willingness to decrease the number of illegal immigration, fight against political corruption, taxes reduction and many others. The so called ‘Government of Change’ made a promise to reform the Italian tax system (which was actually imposed by the central and regional governments and then collected by the Italian revenue agency) by introducing the concept of ‘flat taxes’, which in short is a tax system with a constant marginal rate, for both individuals and businesses, leaving no-tax area for low-income households. It is important to emphasize that the consequences will not only have an impact at national level but also in neighborhoods countries, such as I mentioned before, France, because it is one of the big holders of the debt that Italy is facing.

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