Italy, the euro area’s third-largest economy, is in its seventh consecutive quarter of recession, facing its deepest economic
and political crisis in postwar history. Contractionary fiscal policy may have appeased international financial markets, but Italy certainly paid the price of exacerbating the eco...
downturn and with it the burden of the country’s huge stock of public debt. Private sector lending and spending remain
subdued and unemployment rampant. Italy’s deep lack of competitiveness requires overdue reforms to the country’s
bureaucracy, judicial system, tax system, and public sector. The implementation of difficult reform is further delayed
by the outcome of Italian elections in February 2013, which gave no single party or coalition control over both chambers
of parliament. The governability of the country has not been assured, making new elections in the latter half of 2013 likely.
Italy’s economic and political crises sharpen uncertainty surrounding the euro area outlook for 2013.
Several of the euro area’s peripheral economies remain ridden by crisis. Greece’s economy continues to struggle,
and its public finances have yet to prove sustainable, despite repeated international rescue efforts led by the European
Commission, European Central Bank, and International Monetary Fund. After a long debate, Cyprus became in mid-March the latest country to be offered a bailout by the
International Monetary Fund and European authorities. The bailout package is set at €10 billion, with losses imposed on
large deposits in Cypriot banks. The country’s second-largest financial institution will be closed and its deposits over €100,000 will be placed in an asset-managing institution. The bailout leaves the island’s economy with a large debt overhang, and the sustainability of its public finances remains in question.
Perceptions about an imminent euro area shake up have subsided since July 2012, when the European Central Bank announced its bond-buying program in defense of the euro. As a result, bond yields against German government bonds declined considerably (Figure A1.12). Beyond market perceptions, deep concerns about the viability of the euro area remain, as austerity measures are sharpening unemployment, social unease, and economic contraction. The
euro area’s salvation continues to rest in the determination of the European Central Bank to uphold its firewall against speculative attacks until deep structural and institutional reforms have addressed the most fundamental euro area flaws. It remains unclear whether European and national politics will stand up to this important test.
Source: Bloomberg (accessed 24 March 2013).
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