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Italy's Election Results Might Yield Progress on Reform



It is no surprise that the results of the Italian political election have unsettled the markets and stirred fears outside the country about the potentially damaging impact on Europe, the United States, and the global economy. The markets appear to be mostly concerned by the absence of a working majority in the parliament, increasing the likelihood of new elections in the near term while undermining the possibility of progress toward fiscal consolidation and structural reform, an objective that the country successfully pursued last year.

One day after the elections, many analysts are not particularly optimistic.

A note of caution is in order, however, because the pessimists fail to take into account some considerations that are worth highlighting.

The experience with Prime Minister Mario Monti's government has shown that the main political forces in Italy fully realized that exceptional circumstances imposed pragmatic choices at the end of 2011. Since then, and until the end of 2012, the Italian government therefore benefitted from loyal and steady bipartisan political support. This backing has greatly enhanced the international credibility of the country, reflected in the reduction of the spread between 10-year Italian government bonds (BTP) and German government (Bund) rates from historical highs to historical lows.

The Italian economy is on a steady sustainability path. On several occasions, my colleague at the Peterson Institute, William R. Cline, has sent a reassuring message that Italy's situation on the debt side is safe, and that it could keep its debt ratio from escalating even in the extreme scenario of interest rates moving close to the critical levels of November 2011 and staying there. The main challenge for Italy is restoring growth, for economic, social, and political reasons. This is what the new government should and certainly will commit itself to do, as I stressed a couple of months ago.

As a result of Italy's actions so far, today's circumstances are less dire than they were fifteen months ago. Again, exceptional circumstances call for appropriate responses that must go beyond ideological prejudice and political self-interest. Italian politics have already shown an ability to react responsibly and constructively to adverse external circumstances. What is currently viewed as a political impasse might therefore be a new opportunity for political parties to respond to the emergency posed by an intricate political puzzle. A strong and effective government soon would greatly enhance the chances of structural reform that would alleviate the negative effects on growth and employment caused by fiscal restructuring, and help speed up adjustment.

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