What Would a Populist Government Mean for Italy and the Euro? Short Cut with Lucio Baccaro and Holger Schmieding

According to polls, Italians will elect a right-wing coalition in less than ten days. Would such a populist government lead Italy into a new debt crisis? We talked about this with Holger Schmieding and Lucio Baccaro.




21. SEPTEMBER 2022



According to polls Italians in less than ten days will elect a right-wing coalition led by Giorgia Meloni and her party the Brothers of Italy (Fratelli d´Italia). Would such a populist government lead Italy into a new debt crisis? At the end of August hedge funds had already built the biggest bet against Italian debt since 2008. What would it mean for the Recovery Plan and the reforms that are associated with it? And how would a nationalist coalition affect the much needed process of closer EU integration?

We discussed this a few days ahead of the elections in our New Economy Short Cut with the Director at the Max Planck Institute for the Study of Societies Lucio Baccaro and Berenberg Chief Economist Holger Schmieding, on September 21 via Zoom.

In this discussion, Lucio Baccaro and Holger Schmieding analyzed the underlying factors of Italy’s debt dynamics and discussed options for action for both Italy’s economic policy and the European Monetary Union (EMU).

Lucio Baccaro began by giving an overview of Italy’s economic and political situation. In his view, the Italian economy continues to suffer from insufficient economic integration into the European Monetary Union (EMU). Its “dysfunctional architecture” has favored especially those member states with an export-led growth model (such as Germany) and a credit-driven growth model (such as Ireland). Some basic characteristics of the Italian economy (e.g., the size of the export sector) preclude this specific type of growth model. Rather, they required economic policy measures to stimulate domestic demand. For a long time, however, actual economic policy – partly due to pressure from the EU – had rather pulled the breaks. The structural reforms, which were implemented especially after 2008, had led to austerity and social hardship. Despite all the reforms, it had not been possible to create significant growth impulses and the resulting discontent among the population had destabilized the political landscape.


Both discussants shared the assessment that Italy is not facing a looming debt crisis. The ECB’s announcement in July 2022 of a new TPI programme (“Transmission protection instrument”) could be interpreted as a signal that it would not fundamentally change its role and would intervene in an emergency. Lucio Baccaro explained that Italian debt dynamics, which unlike all other EMU countries had been characterized by an on average positive interest rate-growth differential during the last twenty years, presented a particularly difficult starting position for fiscal policy in Italy.


In contrast, Holger Schmieding argued for growth-promoting reforms in the public sector (i.e., streamlining of bureaucracy) and in the labour market. In this view, these reforms are necessary to achieve higher growth rates, which in turn would lower interest rates and thus avert the snowball effect of the already unfavorable debt dynamics. Lucio Baccaro, on the other hand, saw no scope for further labour market flexibilization, as real wages had already been stagnating for two decades. While there was disagreement on how to assess the German labour market reforms of the early 2000s, they both saw potential for certain “second generation” reforms, such as in the public administration and the judicial system. From the audience, Antonella Stirati objected that austerity had not led to the desired growth successes, but rather had left behind drastic negative consequences. She explained that, for example, public investment in Italy had been cut much more than in other European countries after the crisis.

“We need a much more activist public sector, an activist state, a state that takes charge of the green transition directly.” - “We cannot afford not to invest in the green transition.”

According to Lucio Baccaro, green transition based mainly on private investment and public-private partnerships will not suffice. To enable this kind of public investment across the EU, fiscal rules would have to revisited. Baccaro argued that a more profound EMU reform would not only make economic sense but would also be popular. In surveys conducted by his institute, German and Italian voters had shown openness towards more extensive risk sharing across the EMU (including through new joint debt). Holger Schmieding seemed more optimistic on the green investments already pledged by the EU.  In his view, an overall of the fiscal framework and decisions over joint debt would have to be preceded by an agreement on new conditionalities.

The whole discussion as Re-Live



The euro was planned during a period in which economic policy making was driven by a deep belief in market liberalism and the near impossibility of systemic financial crises. This belief has been brought into question since the euro crisis, which showed that panics do happen. New thinking needs to focus on developing mechanisms to protect eurozone countries from such panics and to foster economic convergence between members.