Thirty years ago, two Italian economists, Francesco Giavazzi and Marco Pagano, published a paper explaining why governments would bind themselves to international economic agreements that constrain their policy choices. External constraint, they argued, was the price for credibility. By tying their own hands, policymakers communicated to markets that they were committed to responsible but painful and potentially unpopular policies. And by shaping market expectations, policymakers made it easier and less costly to achieve their own domestic goals.
For roughly two decades, running from the late 1980s until the start of the global financial crisis in 2008–09, Italian policymakers have used that notion of external constraint—in Italian, vincolo esterno—to introduce substantial reforms to pensions, labor markets, and government finances. As prime minister, Romano Prodi even used vincolo esterno to help Italy meet the requirements to join the euro.
Yet Italy’s new government, an alliance between the left-wing populist Five Star Movement (M5S) and the right-wing populist Lega, has declared an end to this kind of signaling by constraint. Their goal, outlined in a 58-page document covering everything from agricultural policy to university education, is to make reforms without international commitments. Italy’s hands won’t be bound anymore.
The problem is that the international constraints agreed to by previous governments have not gone away. Rome remains enmeshed in EU procedures for macroeconomic policy coordination, which require it to cut its debt and deficit and reform other economic institutions. Furthermore, Italy is more dependent upon markets now than ever before. If markets suddenly change their expectations about Italy—if they believe that the new government will not abide by the commitments of previous ones—borrowing will become more expensive and policymaking more complicated. Giavazzi and Pagano were right about that. Italy’s new government has declared an end to signaling by constraint.
The new coalition partners seem not to care. Indeed, they appear eager to demonstrate that they are willing to pay for greater room to maneuver. This desire to
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