How Mario Monti can solve Italy’s immediate fiscal problems

Italy has a lot of debt, but also lots of wealth.   There is, however, no need to sell off the Pieta.  More than half of Italian government bonds are held domestically.  Apply a wealth tax and use it to pay off all of the domestically held bonds; in essence the government takes the wealth with one hand and mails it back with the other.  The debt/gdp ratio is more than cut in half and the announcement to do so comes immediately.  The Italian citizenry is not poorer, although they are required to recognize losses which already have been incurred.  The Italian government also can do some fraction of this, and retire part of the domestically held debt, rather than all of it.

NB: I am not predicting this will happen!  And while it would not cure Italy’s underlying growth problems, and could make some of those problems worse, it would buy them time.

What’s scarce in this situation is trust.  Why should Italian taxpayers think they will get the money back?  And the intra-Italian redistributions of wealth — from homeowners to bondholders most likely — won’t be popular.

A riskier version of the same idea — not recommended but an instructive point of comparison — is to simply default on all domestic debt and be credible on foreign-held debt to the hilt, maybe sending the foreign debt holders Perugia chocolates in the mail.

The Germans of course understand this logic, which is one reason why they are not going to set up a Eurobond or sign off on ten percent inflation.  Rightly or not, they actually have the gall to expect Italy to pay for the money it has borrowed. (Like so many bloggers, they tend to frame the issue very much in moral terms, though from a Germanic point of view, instead of fully blaming the ECB.)  Italy can indeed do it.


Will?  I don’t know.  I’m not counting on it.


Bonds, schmonds, ... bookeeping! A one-time capital levy is called for. Hardly any incentive problems if you do it just once [more].

In this morning's Telegraph it is remarked that "..the Italians [are] much richer per capita than Germans or Americans".

If you take the value of real estate, it's undoubtedly true. Of course, you can't eat or fuel an economy off of marble, beyond some limited amount of tourism.

You say it in jest but it is worth contemplating a one-time-something. Problem with capital levy is the disincentive, the resentment anger and capital flight, and then the worry about how government will spend the proceeds. One-time reduction of existing barriers to liquidation of/in enterprises would be more creative, coupled with a chocolate dipped default. If Italy suffers severe chocolate deficit for a decade so be it. Any disincentive effects are likely to be crowded out by new investment rush if coupled with a comprehensive raft of Doing Italian Business More Easily law. There’s no hope of an external ad hoc prop. Super Mario is on record as agreeing with president of the Bundesbank who has admirable respect for the legal parameters of creative destruction. Another commenter points out, and I’ve been predicting, Germany will trade money for conditional institutional reform. Sooner people get that through their heads the sooner predictability will be restored. Blunt messages from the creditors and from the authorities will help.

At the FT the Bundesbank president said over the weekend:
“I cannot see how you can ensure the stability of a monetary union by violating its legal provisions,” Mr Weidmann argued. “I don’t see how you can build trust in a system that violates laws.”

Sure, just this once we'll do it and then never again, trust us. ;)

I'm pleasantly surprised. A libertarian suggesting a new tax. And a wealth tax even!

Tyler is much more sensible than doctrinaire libertarians.

He may be more sensible than a libertarian, and he may be more agile than a birch tree, but I assure you he is every bit as much a libertarian as he is a birch tree.

There are no such thing as libertarians.

There is no movement.

No-one fought or died for it.

All there is millionaires and wannabe millionaires and academics spouting to each other and/or captive audiences in campus or fellow bloggers.

"wannabe millionaires" = everyone except billionaires?

+1 for Cliff.

Fine, clever comment.
But libertarianism is about as realistic and likely as anarchism.

Fine, clever comment. But libertarianism is about as realistic and likely as anarchism.

There's nothing outlandish about either social liberalism or fiscal conservatism. The fact that, in the U.S. the parties are aligned across this fault line rather than along it is an historical accident. Party realignment across issues like that doesn't happen often or quickly, but it does happen. The tenets of anarchism, on the other hand, are held by a very tiny slice of the population.

A capital levy equal to 60% of GDP ...

On what planet?

If you treat debt held by citizens differently than debt held by non-citizens, you open the possibility of strategic trading that likely defeats what you're trying to accomplish. Citizens buy or sell, depending on whether you're paying or defaulting.

Germany may talk the language of morality, but it's acting in what it perceives its own best interest, even if that harms citizens of other countries. It's using morality as a talking point, not behaving in a moral manner. Germany's policies are going to hurt a lot of vulnerable people who's main sin is living in a country that can't devalue its own currency.

Alas, the main sin is living in a country with a dysfunctional polity. It's hard to blame this on individuals. Nevertheless, some have to pay. The only question is who.

I'd like to second the point about the bonds. Converting Italian bonds into two classes will probably drive up interest rates on the foreign held bonds -- whether this leads to overall reduction or increase in borrowing costs for Italy is not clear.

Or it could renounce domestically-held bonds, which also does the same intra-Italian wealth juggling, albeit from bondholers to households...

Bondholders and Homeowners in Italy are roughly the same: 50-60 yo highly protected employed people who are in full possession of their houses. I would go for the proposal.

But wouldn't that be equivalent to default on domestic debt, though? Italian households lent their savings to the government in exchange for some return in the future. With this proposal they would get zero, right?

Wouldn't most domestically-owned bonds in fact be owned by Italian banks, insurers, pensions, etc? Not 'homeowners'.

Hm. Italy has a net primary surplus and unchanged net public debt the past 10 years. US has a 8% of GDP prim deficit. What is so unsustainable about Italy? Really.

Italys primary balance is better than Germany. This is pure liquidity crisis - and not solvency.

Sooner or later financial markets will realize that a default with 30 pct haircut or with a 30 pct devalution is exactly the same. That will be a very sad day for us Treasuries (by the way, Chinese people have allready undestood that simple principle and they are buying euro). It's really crazy this financial dream that US financial system is safer because US can print (and devalue) their own currency. It totally recall me the financial folly of 90s regarding the resilience of US consumers: Private debt? not a problem, sir !! Could someone tell me why the markets can be so irrational for so long?

Maybe because you are wrong

Regarding the US Consumers ? markets spent more than 15 years sayng that the us leveraged consumer was not an aberration ! now we know how it ended

Good point however it is far from true that Germans view this solely as a tale of morality. In contrast to many people who seem to think that capital comes from the printing press Germans value savings because they understand that ultimately all forms of capital are a result of savings. The main point is not that savers get punished and debtholders rewarded, it's that once savers see this happen they lose their incentive to set money aside and capital formation suffers as a consequence which hurts the economy in the long run. One of the reasons why Germany is in such a formindable position is precisely because its workers enjoy such a huge boost to productivity through earlier-aquired (human, investment etc) capital. Germans are afraid that if savers stop saving, it will have a negative effect on the future capital stock of the economy.

Italy should never have been allowed into the eurozone. Why? Unless there was a credible commitment to change their political economy the result was always going to be inevitable. Precisely because Italy was unable to make a) productivity gains through reforms and b) live within its means it had to resort to devaluation and inflation. In the abscence of a reforms Italians got used to handling the issue of lost competitivess vis-à-vis Germany through devaluation. Now that they cannot devalue their political economy, of course, comes to a grinding halt. Italians didn't inflate and devalue because they enjoyed adding zeroes to their bills, but because in the abscence of tough reforms that was the only way they could stay competitive. Their political economy didn't react to the loss of monetary sovereignty with the needed reforms and now it's too late. Unfortunately most people seem to have missed that point about Italy.

This is so stone age, I don't know where to begin. Central banks can print up all the savings you need. [/sarcasm]

Incidentally, if people though that the likes of Krugman or Bernanke had it hard on US websites and blogs, they'd be astonished if they read what Germans utter about them on both left-leaning (Spiegel) and right-leaning (FAZ) websites. Suffice to say that they're not exactly helping the reputation of Anglo-Saxon economists.

Germany's big economic idea of the past 50 years is about to explode spectacularly and take Italy, Greece, Spain and France down with them. Suffice to say they're not exactly helping the reputation of German economists.

Read the comment above yours "Italys primary balance is better than Germany. This is pure liquidity crisis – and not solvency."

The issue isn't productivity, reforms, living within one's means, etc. Italy would be fine paying a normal interest rate. It's only because of a run-on-the bank type market demand for higher interest rates that Italy has a problem. If the market for some reason (including irrationality) demanded the same rates from Germany, Germany would have a major problem.

It's a judgement call whether it's just a liquidity crisis or a solvency one. Given the evidence and current trajectories of inflation and other relevant factors I think it's safe to say that we're talking about a solvency crisis caused by a debt stock that was too high. Italy has a major productivity problem and has lost up to 30%-40% against Germany since joining the euro. Greece wouldn't have a problem funding itself if people were willing to lend it money at German rates, I don't see your point. The reality as of now is that the market demands a higher interest rate and while you may think that this is unfair and self-fulfilling, this is what is happening and this is what has to be dealt with. We would need to know how much the ECB bought and who sold to them in order to fully understand whether it's more of liquidity crisis or solvency crisis.


All insolvencies look like liquidity crises in the beginning, and I am giving credit to Italy to not be fudging the reported numbers, or hiding some of the debt in non-sovereign entities like Spain's Cajas and local governmental organizations. Also, I would be giving credit to them not to have other off-balance sheet quasi-liabilities like the US's SS and Medicare promises (which, of course, would be a clear error on my part anyway).

Seriously, arguing that people are irrational to want higher rates to continue to cover Italy's accumulation of debt is a bit daft at this point. The truly irrational may be the ones willing to loan it to the Germans.

"Seriously, arguing that people are irrational to want higher rates to continue to cover Italy’s accumulation of debt is a bit daft at this point."

Again an argument by someone who simply has not looked at the numbers. Italys public debt/GDP ratio has not risen the past 10 years.

In general no Euro area country except Greece has anything that remotely look like a major fiscal sustainability problem (far from the US for instance).

And now you mention Spain. Spain still has lower public debt/GDP than Germany and even is you assume that they have to take over all Cajas well below 100% of GDP.

Sure there is a productivity problem in some countries. But not clearly in Spain for instance. And the OECD labor productivity stats are clearly flawed and biased by the rise in temp workers in Southern Europe, itself a product of easing labor regulation the past 10 years.

It is only 10 years ago that I had to hear about how Germany would stagnate forever because it entered EMU at uncompetitive DEM levels and because of East Germany and because of labor market rigidities. Come on.

Written by someone that actually trusts the official numbers, both on the debt and the deficits. You are also ignoring the quasi-liabilities, just as I pointed out. It isn't valid to say a debtor can carry a debt if only the creditors would give him a low enough rate, and/or roll over the debts indefinitely. In addition, you want to look at total debts, not just the government ones.

To Carsten Valgreen: the important difference between Italy and USA is that all of US debt is denominated in US dollars, a currency which the USA fully controls. All of Italy's debt is for all intends and purposes in a " foreign" currency. The same holds true, more or less,bat least in practice, though not in theory about the divide between Italy and Germany - the Bundesbank controlling practically with ECB.
To Firat Uenlue: if capital does not come from the printing press but from savings as you seem to think that the Germans think, then where do savings come from? In a fiat monetary system, all money comes either from the "printing press" ( I put " because majority of the money that used to come from the real printing press now comes in electronic form), or comes in the form of debt. The problem is that majority of economists and politicians these days still seem to think that we operate a gold standard and thus have prevented the creation of money and rather have resorted to the creation of debt which is partially why we are dealing with this debt crisis in the developed world.

Obviously in a fiat-system money comes the printing press. You cannot however print savings i.e. capital without diluting the money stock which existed prior to a monetary intervention. We could hand over parliament the right to the printing press but there's a reason why we prefer to have banks work in an intermediary role.

The Fed under both Greenspan and Bernanke has been printing money with wild abandon in a long failed attempt to inflate the US to wealth and prosperity. Interest rates are zero on short bonds while inflation is 1-2% and even long bonds are under 3% with Ron Paul screaming "hyperinflation" based on his believing the Fed is doing what you say the Fed can do.

Yet the more the Fed and Treasury and logic and reason say the US controls the value of its money, the US dollar has been holding its value.

Besides, California is only 10% smaller an economy than Italy, 50% larger than Spain, and 6 times larger than Greece, and it doesn't have its own currency and is loaded with debt and a dysfunctional constitutional government - the voters of California have written their constitution to mandate spending while making increasing taxes to pay for the mandates effectively impossible. I see no difference between the voters in California, Italy, Greece, Spain,...

The weird voters are those in Germany who vote for taxes and crushing environmentalism and have mandated union power in corporations plus have a highly controlled health care system and relies heavily on manufacturing. On every account, conservatives have blamed the problems of California and much of the US on all the crushing burden of big government that Germany does twice as "badly". But most important, Germany has more control over the value of the Euro than California over the dollar.

The Eurozone is like the US in 1786 when Congress needed every single State to vote yea on all the important matters, and Rhode Island always voted no. Later Rhode Island was given a choice - give up sovereignty or be booted from the dollarzone. What good would it have done Rhode Island to be independent then, or now? Could Rhode Island solve its debt crisis if it had its own money it could print to inflate? Explain how Rhode Island would be better off outside the USA. Or California, for that matter.

RI could be a free trade tax haven like Luxembourg if t where not part of the USA. Many very small countries do quite well. It is obvious in small countries that restrict trade is bad policy because they know that they cannot make everything they would like to consume as efficiently as they can trade for it. Also they would have a lower military burden.

Antont: Agree, that is the difference. Which makes this a liquidity crisis and the lack of a lender of last resort the central problem. Not public debt levels or productivity. The EMU experiment has failed unless European politicians force the ECB to open the firehose on the fire. Its that simple.

Well and succinctly put

Why default on domestic debt and not on foreign debt? The political and economic incentive is to do the exact opposite. Sure, Italy would lose access to foreign credit, but they have a primary surplus anyway.

Russia 1998 provides the answer to your question.

What I like about Cowen's idea is that it explicitly lays out the ultimate outcome of loaning to a sovereign- it is just a tax you willingly pay later, either through some contrived tax like the one outlined in this post, or via a default.

The question is, will everyone else do worse on that tax than you will.

Italy did a wealth tax once before, and since the persons taxed are also the beneficiaries (except for foreign wealthholders), it is as if TARP costs were being paid by bank depositors rather than general taxpayers. About a month ago some wealthy Frenchmen were talking about increasing taxes on the wealthy for the same reason--to protect their bonds.

Monti can also improve tax collection. According to the WSJ, "He [Monti] will have to crack down on widespread tax evasion—a scourge that officially accounts for 18% of gross domestic product, but is much higher in certain regions and pockets of industry."

The Greeks taught the Romans.

Or how about 50% tax on bonds, if we want to avoid terms "partial default" and "haircut" so much?

The only question is who will pay.

Problems: You will need a totally new assessment system to measure people's wealth and stop capital flight. I think it is easier to collect an income tax and they have a big problem with doing that. If it is just a tax on the government bonds, everyone will try to dump them and push the interest rate up higher... So I don't know why this is better than enforcing income tax, raising the rates or raising VAT rates if you want to get more revenue.

Precisely. Not bonds or bank accounts, but real, immovable wealth.

+1. A tax on land is impossible to evade.

A one time tax doesn't have the problems you identified.

"Rightly or not, they actually have the gall to expect Italy to pay for the money it has borrowed."

Another way to phrase this:

Rightly or not, they actually have the hubris to expect that German lenders to always make money.

Matthew Yglesias makes a good moral point on borrowing and lending. In the case of our subprime loans, the lenders had far more expertise than borrowers, so they should be at fault if the loan deal goes bust. In the case of Euro-denominated bonds, both lenders and borrowers should have roughly equivalent expertise (I'd even venture to say maybe the Germans should know better?), so *both sides* should be at fault.

Germany should suck it up in inflation and Italy tackle the rest with paying down debt. The way you figure that out is by determining the level of inflation that allows Italy to keep up with its loans with its current primary surplus.

The thing that's impossible to move abroad is land. So tax that.

Heard that sound? That's another Swiss bank account opening...

"Apply a wealth tax..": and count the cars crossing the border to Ticino to shift deposits to their Swiss bank accounts. Wealthy Italians are not a captive population. This tax would hit the pensioners and middle class savers.


The Swiss have put credit controls in place to limit increases in foreign deposits to prevent the Swiss economy from cratering.

That's good news for the airlines. Now Italians will have to fly to the Caribbean.

Uh, what sorts of taxes does Italy's constitutional law allow? What sorts of taxes do Italian politics allow?
How you sell tax increases when you are running a primary surplus?

Also, from a real world point of view, defaulting on a bond, or taxing the bondholder some huge amount of its value, or inflating it away, are in effect the same thing. So the Real World Return of Italians buying Italian bonds is seriously negative after taxes - why would any government think they could borrow money in the future in such circumstances? (Perhaps some citizens won't notice - but in the age of the web more and more people will have it explained to them.)

Finally, if what Italy really faces is a kind of "bond run" (the bond equivalent of bank run?), then the real issue is confidence about the future rather than cash flows on hand. If the run is severe, they could be forced into default no matter what they do. On the other hand, if they can persuade enough elements of the bond market that they will straighten up and fly right, they will escape.

I think it is now pretty clear what the German solution is; basically their price for ECB printing money to save Italy/Greece etc is to have them reformed and be more like Germany under EU institutional control. Of the three possible options, they are choosing the one that makes most sense. Option 1 is allow Greece/Italy to default, pretty disastrous for the world economy, option 2 is Germany leaving the Euro, too hard and risks sky high DM, so we are left with option 3, allow the ECB to print money to buy the Greek/Italian debt. However Option 3 has huge obvious moral hazard risk (which the German voters recognise). So how do they manage the moral hazard? By taking over the institutions with proxies who are credible to deliver reform, like Monti. If Monti is unable to deliver, the squeeze goes back on. This is the first time I have actually seen (or maybe understood) a credible strategy for resolution of the problem - a huge step forward.

Once it is clear that the reform process is entrenched, expect the Germans to allow the ECB to be more specific about support for the Greek/Italian bonds. Yields will then fall and the debt burden will be more manageable for Italy/Greece. Actual repayment of the debt by Italy/Greece is not a problem once their debt is owned by ECB, the ECB can continue to roll over the debt in perpetuity.

In the long run I would say that the effective colonization of Southern Europe could be very beneficial for these countries, similar to the way Hong Kong benefited from British rule of law, with law makers remote from local corruption influences. I know Italy very well and in my view, the biggest issue with their economy is the endemic corruption - worse than in Russia in many ways. No-one can rely on the law courts or the police for anything other than the simplest matters. The land registry is a mess as well. Fix these things and Italy could be a very strong economy, it has a lot of human capital, Italians are generally incredibly hard working and usually pretty smart. Their cultural offer (increasingly important - have you seen Korean, Taiwan or Singapore advertisements trying to establish some kind of brand?) is the best in the world.

Best, clearest, and (I believe) most accurate analysis I have read so far. Thanks.

good strategy. only question is how to "put the squeeze back on" after the Monti government fails. Oh and one other thing - how to get the Southern EZ countries to continue to buy lots of German manufactured goods now that the Germans don't want to lend them the money with which to purchase it. Clue: another Opium War is not the solution.

Thought experiment:

What percentage of economic theory, and economic dissertation, is dedicated to justifying the idea that of COURSE governments should spend every single dollar they can pull in, and then borrow more and spend all that too, and then keep borrowing more until the spigots are finally cut off decades later, and then bailouts and partial defaults will inevitably follow, but that's really someone else's problem... and that this is all to the good?

It's certainly more than half. But is it 80%? 95%?

So what's causing the underlying growth problems?

Negative native population growth.

Euro membership

Since they joined the Euro Italy is #3 from the bottom in GDP growth, ahead of Haiti and Zimbabwe IN THE WHOLE WORLD. Hmmm. That happened simultaneously with joining the Euro because Italy suddenly became corrupt and lazy in 2000?

This discussion would be a lot easier if any of you had been in Russia before and after 1998.

The first thing the IMF tells a country when it takes a loan is for them to raie taxes. This inevitably ends up digging that country further in the hole. I think countries tend to tax near the revenue maximizing point, so I don't really see another tax actually helping much.

A holds a bond an B owns stock. Under one proposal B loses his stock to pay A. Under the other B keeps his stock and A loses his bond. How are these equivalent?

To me the question is how a government that takes the Tylerian pill can stay in power. It's pretty hard to screw the population directly and transparently and still stay in power.

Whatever be its economic merits this plan is political suicide.

Well, assuming a Democratic form of government it is political suicide. But China does it just fine, because they don't have any accountability to their own people.

Not that I necessarily believe, Italy (or Greece or Spain) will give up their democratic institutions, but this may enforce a government that is less prone to the 'bread and circuses' type of corruption.

"The Italian citizenry is not poorer..."

Umm. If I'm a wealthy Italian with a $10,000 euro bond, then you take $10,000 euros from me and pay off my bond, suddenly I have exactly the same amount of wealth as before your tax except now my bond is gone. Isn't that more or less equivalent to defaulting on domestically held bonds?

I agree. I think many Italians would like to use the proceeds of the bond *and* their wealth to finance their retirement. Now they're left with only the proceeds of the bond.

I also agree. Tyler suggests taxing wealth (houses, shares, govt bonds etc.) and using the proceeds to pay back some or all of the government bonds that are held domestically. What could possibly go wrong?

This would be a huge transfer of assets away from the private sector. Assuming (big assumption) that there is not a revolution, the private sector would have to double down on its savings to get back to where it was before.

In order to pay this one-off tax citizens would also have to convert their assets into cash - thereby depressing already depressed markets.

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Just out of curiosity,

When was the last time taxes were raised on the wealthy, if not in the U.S., then some other country?

Apply a wealth tax and use it to pay off all of the domestically held bonds; in essence the government takes the wealth with one hand and mails it back with the other.

But not to the same people. It would be a tax on people who made the smart decision (to invest their money paying off the notes on their house or business, for example) and a bailout for those who made poor decisions (to invest their money in Italian government bonds). A tax on the prudent in order to bail out the foolish -- moral hazard & bad incentives.

The Italian citizenry is not poorer, although they are required to recognize losses which already have been incurred.

Some Italian citizens have losses they have yet to recognize (namely, government bond holders). Other Italian citizens, those who own real property, do not. The latter are much more likely to retain their assets & wealth, even with a possible default and euro-zone exit (why would the owner of a hotel in Tuscany be impoverished because English tourists started paying in lira?) -- so long as the government does not impose confiscatory wealth taxes. Am I wrong in seeing this proposal as fundamentally anti-libertarian? Treating 'the citizenry' as an undifferentiated mass and not seeing them as separate from the state. "Italy has a lot of debt, but also lots of wealth". I would say, no. The Italian national government has a lot of debt, but the Italian people have a lot of wealth. To a libertarian, that distinction should be critical, shouldn't it? The property does not belong to the state.

Wealth taxes tend to destroy wealth unless they are very, very small. Assets only have value if there is someone who is willing to buy the asset. If the asset carries a tax with it, buyers have to capitalize the future taxes and that comes out of the asset's sales price, implicitly if not explicitly. And then there are huge admin costs, because how do you know someone has offshore assets, how do you value art, etc. A wealth tax penalizes the honest and creates manifold loopholes for the less honest.
And Italian demographics being what they are, a wealth tax at the margin forces asset sales to foreigners, many of whom are basically seeking to launder money. Essentially a liquidation of your citizens' wealth to pay sovereign debts.
Last, in Italy, the north has the wealth and the south is the fiscal drain so there would be tremendous sectional strife from this approach.

But it would be a one-time tax!!

Ok, I am being sarcastic again.

Italians do not obey laws just because they are laws democratically enacted so that makes it difficult to collect any tax let alone a wealth tax. I think that they will have to default in some way. IMHO the benefits of being able to borrow are overrated.

To me the 2 benefits of borrowing are:

1. To move some of your consumption earlier in you life when it is more enjoyable.
2. It enables businesses with good ideas to grow faster.

A balanced budget amendment results in the same thing a government that cannot borrow. also borrowing is not a great idea if you like Italy have rapidly falling population.

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