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The BBC reports that the European Commission has told Italy to revise its budget, saying that the draft presents particularly serious non-compliance with Eurozone rules. Yet the maximum permitted deficit is 3% and the Italian government states that its budget has a deficit of 2.4%. If the Italian budget deficit is less than the maximum permitted 3%, on what grounds is the European Commission telling Italy it must revise its budget?

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    "...the maximum permitted deficit is 3%..." That's not the only limit. There is also a maximum limit on the debt. I think it was detailed in the Maastricht treaty. I guess legally there is an argument to call out the Italian government with the second highest debt in the EU, although in the past such cases were not handled consistently at all. – Trilarion Oct 25 '18 at 10:43
  • Limits are not goals. Keeping things under limit is one thing. Keeping things at the level that's best is another. – fredsbend Oct 26 '18 at 21:36
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Italy is not just planning a high budget deficit, it has a very high level of national debt. (As of 2017, it was 131.8% of their GDP, second only to Greece) This makes their deficit riskier than it would be for a country with a lower level of overall debt. Italian banks also own a lot of that debt, and there is a fear that government intervention in the banks (which has already been taking place) could lead to a vicious cycle, collapsing both.

It is worth noting that the Italian government running a substantial deficit is a fairly new phenomenon - they were able to calm investors until recently by running a budget surplus.

Sources:

Wall Street Journal

CNN

  • I also wonder if 2.4% would be the ceiling - this seems like a big increase in government outlays. It's not unusual for a government to say "we're going to run a deficit of x%" and then have that go up in practice. Though I don't know if the EC has acted pre-emptively on over-optimistic forecasts in the past - certainly the 3% limit has been more observed in the breach than in observance, until recent years. – Italian Philosopher Oct 26 '18 at 16:33
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It appears the problem isn't the deficit (the loss from an individual budget) but the size of the existing debt itself. From a report in the Guardian

Italy’s public debt is worth more than 130% of the country’s GDP, the second-highest level in the EU after Greece and more than double the bloc’s limit of 60%.

In effect, the EU don't believe that the budget the coalition have announced represents a serious attempt to control their spending, or to honour previous promises made when receiving EU financial support.

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    Note that other major EU and Eurozone countries broke the 60% debt and the 3% deficit targets, but not by as much and not quite as unapologetic (the latter is a value judgement, of course). – o.m. Oct 24 '18 at 15:45
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As mentioned in previous answers, it is not just about the deficit but also about the already high level of national debt.

Furthermore, the Italian government was initially expected to aim for a 0.8% deficit in 2019 before announcing last July that they would not be able to hold that.

So instead of reducing its deficit as expected, the Italian government is expanding it by quite a bit. And while some expansion can be tolerated, this one poses a lot of problem because of its structural nature. Indeed, some of the reforms that the Italian government wants to carry out (and so included in their 2019 deficit/budget), such as a basic income, lower retirement age and lower taxes are structural in the sense that they will have long term effects on spending and so on the government's deficit. This is contrary to what the European Commission is trying to achieve: healthier budgets/finances

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    They might also boost the economy by increasing total spending (pensioners spending the little bit of extra money they get), thus increasing the GDP as well as tax income. But that's not how the European Commission likes to reason :) – gerrit Oct 24 '18 at 18:09
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    @gerrit They need to stop eventually. Say the entire country worked all year long, and spent exactly $0 that yr. A swarm of tourists equating the population of Italy itself arrived, and bought everything all year long as Italians would have if they could spend their own money. That also means tourists paid rent and every Italian was homeless and didnt need to eat that year. Finally, each Italian donated their salary to the debt. They would still have debt left. "Boosting" the economy can only work so long. How boosted can an economy be when they're being held down by interest payments? – Nicholas Pipitone Oct 25 '18 at 0:28
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    @NicholasPipitone If economic growth or inflation exceeds debt growth, they don't need to stop, ever. Many support a countercyclical fiscal policy, paying off the debt when the economy is booming and spending to boost the economy when the economy is doing poorly. You are right to point out that imports and exports (including tourism) complicate the picture, which is why Keynesian economics does not work on a city level, and may work better on an EU-wide level than on a national level. But this comment thread may not be right place to debate austerity vs. countercyclical fiscal policy. – gerrit Oct 25 '18 at 11:28
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    @gerrit My point was beyond that. They are deep, deep, in debt, regardless of which monetary policy they're a part of (Both austerity and countercyclical are valid in my opinion, it just depends on the goals of the state). My theoretical picture was of a year of work that would give unheardof levels of foreign money, and they still couldn't pay it off. The average American gets interest rates better than the country of Greece. It's pretty awful when a random human is more accountable than a country, when management should theoretically occur by the most responsible and intelligent. – Nicholas Pipitone Oct 25 '18 at 16:33
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    Ideology is different imo. These levels of debt is just, irresponsible. Someone who makes 100k/yr should never have 150k in debt, and then continue to get more debt. Of course, countries are a lot more stable and dont have to worry about "Oh no I have cancer", etc. However, clearly investors are worried and are giving Italy interest rates of 2.96%, but giving loans to Germans out at 2.1%. Italy shouldn't have a risk of default literally higher than a German citizen - that's horrifying. A person defaulting is bad for that person, but why should an entire country ever get to that stage? – Nicholas Pipitone Oct 25 '18 at 16:44
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Italy doesn't infringe on its obligation to keep its deficit below 3 %, but on its obligation to keep its debt-to-GDP ratio below 60 %. Most countries in the European Monetary Union (EMU) have an excessively high debt level after the economic crisis of 2007, but all countries seem to be engaged at stopping the debt from spiraling out of control.

Italy is the outlier. It openly defies the rules of the EMU. The Italian government doesn't seem to be serious about stabilising or even lowering its extremely high debt-to-GDP ratio (about 130 %). The government wants to simultaneously increase its social spending and lower its taxes. Higher spending and lesser income doesn't lower one's deficit. Sure, the Italian government predicts that its reforms would unleash economic growth, but neither the markets nor the non-Italian EU politicians believe in these predictions.

It's not only about Italy being a bad example. (Others have been, too.) The Italian budget directly threatens the economic stability of Italy and the survival of the EMU. If a country with a lower debt-to-GDP ratio (e.g., Estonia, Bulgaria, even Germany) did so, nobody would be seriously concerned - but in the case of Italy a default seems imaginable. And Italy is not one of the smaller member states! The European Central Bank is already owning a huge pile of Italian government bonds and would be obliged to continue buying them in large quantity. The markets don't want them as shown by the large spread. (= risk premium, the difference in interest between Italian and German government bonds, which are considered almost risk-free) The ECB-owned bonds would lose much of their value. Furthermore, the citizens of the other Euro countries would be on the hook for an Italian banking crisis.

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    Is it possible to cite some evidence to prove EU policy on budget varies based on debt-to-GDP ratio? As well as why a default is possible in Italy's case? I think this would make this answer much better. – inappropriateCode Oct 25 '18 at 15:11
  • @inappropriateCode: – Frank from Frankfurt Oct 26 '18 at 8:37
  • a) I didn't claim that EU policy is a function that depends on the debt-to-GDP ratio except for the binary decision "below/above 60 per cent". I only said that a high deficit is perceived as a larger concern, when accompanied by an already high level of debts. (IMHO it's highly plausible that more "flexibility" would be shown in such a case. It would be interesting to see a good-quality econometric paper analyzing the real motivations of past EMU decisions.) – Frank from Frankfurt Oct 26 '18 at 9:07
  • b) One proof of your second question is contained in my original answer: Why would anyone prefer lending to another country that offers a lower yield at equal risk? The spread is a market estimate of the likelihood that a country doesn't repay in full or not at all. – Frank from Frankfurt Oct 26 '18 at 9:07
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    I'm not saying I disagree with your argument, it seems fairly common sense. What I'm saying is that it would be a better answer if you provided a link or citation to evidence that this is exactly what the EU/ECB has said on the matter. – inappropriateCode Oct 26 '18 at 9:11
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Rich countries are interested in low inflation because inflation reduces the general worth of money and therefore penalises those who were wealthy enough to save and lend their money to others. Poorer countries with debt on the other hand are interested in moderate inflation because the reduction of the worth of money means the reduction of the value of their debts. Currently there is low inflation despite the steps taken to expand the euro in circulation through quantitative easing. In anticipation of rises in inflation it appears the ECB/eurozone (i.e.: Germany) is pushing for lower deficits. If quantitative easing stops (as is planned for the end of this year) countries with high deficits (and high debts) will have trouble financing themselves. At that point there will be a crisis, and the solution would either be to reinstate quantitative easing which the rich countries in the eurozone do not want, or the country would have to leave the eurozone. While the leaving of Greece from the eurozone would have perhaps a small impact, Italy on the other hand is a large country which can have a much larger effect on the eurozone.

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