Italy Is Too Big to Fail, Making the Eurozone Vulnerable to Blackmail

Details from the coalition negotiations between Italy’s far-right populist party Lega Nord and the Five Star Movement have caused a stir on the financial markets: their plans to massively increase public spending and cut taxes, and especially their demand for a debt relief of 250 billion euros of TARGET 2 liabilities have spread uncertainty across the European Union. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at the Centre for European Economic Research (ZEW), Mannheim, shares his thoughts on this development.

“Italy’s proposed government programme is completely rational from the perspective of these two parties. The populist parties are playing their trump card and there is not much the Eurozone can do. Unlike Greece, Italy is indeed ‘too big to fail’. This makes the Eurozone vulnerable to blackmail since it must avert a financial collapse of Italy and its banks at almost any cost. Even if the debt relief of the TARGET 2 liabilities proves unrealistic, a populist government is very likely to put an end once and for all to the Stability and Growth Pact. The two cardinal mistakes the EU made in its euro policy are now taking its toll.

First, the European Commission and the Eurogroup have been too lenient in the application of the Stability Pact in the past years in the face of potential election victories of populist parties. This has encouraged voters to support these parties. Second, Europe has yet failed to develop a strategy for dealing with sovereign default. The implementation of an insolvency procedure for euro states, which has long been proposed by many economists, has been treated as a taboo subject.

In addition, the EU has also failed to introduce measures that could reduce the unjustifiably high concentration of sovereign bonds in the balance sheets of banks. If it comes to a poker showdown between the new government in Rome and the Eurogroup, it is entirely unclear who will win. In any case, we are likely to see a long period of uncertainty, with the reputation of the euro taking further damage.”

For further information please contact:

Prof. Dr. Friedrich Heinemann, Phone +49 (0)621/1235-149, E-mail friedrich.heinemann@zew.de