Monetary Policy in Pre-ECB Italy
Bartolini, Leonardo, New England Economic Review
In 1979, Italy entered into the Exchange Rate Mechanism (ERM) as a founding member of the European Monetary System. After that date, the country's monetary policy was geared toward the maintenance of exchange rate stability against its ERM partners, despite a number of exchange parity realignments and with the exception of the period from September 1992 to November 1996. (1) The strength of the ERM commitment was not uniform over time, either in terms of amplitude of the fluctuation band (2) or in terms of frequency of realignment of bilateral parities. Despite this variability, however, changes in official rates--the discount rate and the rate on fixed term advances--were overwhelmingly linked throughout the ERM period to developments in foreign exchange markets.
The broad exchange-rate stability objective was made operational as a target range for the overnight interbank deposit rate. This target was articulated as a corridor (in the 1990s, of typical width between 1 and 1.5 percent) effectively determined by the rates applied on Bank of Italy lender-of-last-resort operations: the discount rate (at the lower edge) and the rate on fixed-term advances (at the upper edge); (3) and by the market-determined tender rate on repos, the main tool used by the Bank to conduct its open market intervention, which steered the interbank rate within the corridor.
Besides entry in the ERM, the year 1979 also witnessed a formal shift in the broad goals of central bank intervention. Until that year, Bank of Italy intervention had been mostly intended to sustain the financing of the public deficit, by means of its purchases of securities directly from the Treasury By contrast, in 1979 the goal of intervention was identified as controlling the liquidity of the money market. Also, in 1981 the Bank was granted formal independence in the pursuit of this aim, when its obligation to acquire all Treasury securities unsold to the public at primary auctions was rescinded. However, despite these changes, the Bank of Italy's ability to control the monetary base and set short-term interest rates remained constrained by a number of institutional arrangements, including the obligation it had to finance the Treasury through an overdraft facility covering 14 percent of annual expenditures. Furthermore, the power to modify the discount rate was, until February 1992, assigned by law to the Treasury, which acted upon proposal of the Bank of Italy. In effect, the main step in the granting of independence to the Bank was not completed until January 1, 1994, when Article 104 of the Maastricht Treaty became operational: The Treasury's account at the Bank of Italy (conto di tesoreria) was reformed, with closure of Bank credit to the Treasury and placement of strict limits on minimum balances held by the Treasury in its account at the Bank.
Other than the release of operational independence to the Bank of Italy, there were limited notable changes in the Bank's operating environment in the course of the 1990s. Averaging of reserve requirements was introduced in 1990. accompanied by a rise in the fraction of free reserves for daily use by banks. Reserve requirements were repeatedly lowered in the course of the decade. (4) And, as discussed below, foreign exchange swaps were included in 1992, alongside standard repo operations, among the instruments for intervention by the Bank in the open market.
The Bank of Italy has engaged in lender-of-last-resort operations (rifinanziamento) only with banks. Three basic facilities were in place for this purpose: ordinary advances and fixed-term advances (as standing facilities), and discounting. By the end of 1998, financing under the three facilities equaled 33 trillion lire (or 24 percent of the monetary base),5 up from a more typical 21 trillion in 1997 (11 percent of the monetary base).
Ordinary advances (anticipazioni ordinarie) were a collateralized overdraft facility for commercial banks accorded automatically, but whose amount was limited. …