If pushed to entirely bear Italian risks, they may face unpleasant credit downgrades. And, as physicist Per Bak wrote, when one fault line breaks, other cracks weaken, causing a cascade of earthquakes. The Italian economy has not grown since joining the eurozone in The economy has remained in near-perpetual recession over the last decade and was already contracting along with world trade before the coronavirus struck.
As the Chinese economy slows down further — and very likely itself contracts— in the coming few months, the lack of Chinese supplies of critical parts and ingredients will cause continuing damage to world production and trade. As people stay home and demand for services falls, the economically vulnerable — especially young Italians on precarious temporary jobs — will lose incomes, and demand will shrink further. Indeed, even if the numbers of new cases begin to fall, the disruption to economic activity will continue.
Stock markets have taken note. Warning bells are also ringing in debt markets. True, these nominal yields, at about 1. And now, the rising nominal rates are threatening to push Italy into a negative feedback loop.
The economic contraction will force the debt-to-GDP ratio up, which could cause a further spike in nominal interest rates. Although many banks have sold large chunks of the loans that borrowers were not paying on time, financial markets have a bleak view of the Italian banking system. European authorities could punish the Italian government for putting taxpayers' money into the recapitalization of the troubled lender Monte dei Paschi di Siena BMPS , but such a decision would prolong the ongoing European crisis, an economist told CNBC on Wednesday.
Media reports on Tuesday suggested that the Italian government is preparing to step in. Reuters reported, citing anonymous sources, that it is planning to take a 2 billion euro controlling stake of BMPS using taxpayers' money — a move that could be considered illegal state aid under European rules. The start of the latest round of discussions of the finance ministers had been repeatedly delayed on Thursday as the main protagonists, Italy, the Netherlands, Germany and France sought to find a way forward between themselves.
The issuing of joint bonds would create joint liability and make borrowing more expensive for the wealthier northern member states as it cheapens it for the rest, at a time when the gap between German and Italian bonds is rising.
The Dutch parliament has backed its government on its approach, with politicians warning that anti-EU sentiment would be inflated in the wealthier member states as well if the electorate concluded that their money was being misspent.
We were also not in favour of this formulation because the idea opens the door to a mutualisation of debt Although the roots of the crises varied, there were similarities in the consequences, in particular a poisonous interaction between stressed government finances and stressed banks.
A country's banks held much of its government debt, so if there were a default it would impose losses on them. Stricken banks would cut off credit to the economy and hit tax revenue and they would lead to extra spending on bailouts. The eurozone responded by creating bailout agencies which borrow money in the financial markets to lend to countries in difficulty.
They involved tough steps to reduce government borrowing - spending cuts and tax increases. Strictly speaking that wasn't part of Spain's bailout agreement, which was exclusively about the banks, but the Madrid government was already working on its own finances. Inevitably there was an impact on public services and living standards, severe for many people. Critics argued that the austerity aggravated the economic problems. It is certainly true that the countries concerned suffered deep recessions.
In addition to the bailouts, there was a key response from the European Central Bank. It created a new programme, called outright monetary transactions, to buy the government debts of countries with bailout programmes and under severe pressure in the markets. The aim was to bring down their borrowing costs to sustainable levels.
Merely proposing to do it did the trick. The ECB didn't spend a single euro under this programme. It did, however, subsequently start a programme of buying the debts of all eurozone countries troubled or not, known as quantitative easing.
The objective was to tackle the economic weakness and too-low inflation across the eurozone, but it did help the government finances in the bailout countries.
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