Bank of Italy Grapples at the Steering Wheel through the High Winds of Public Deficits

By Ciampi, Carlo Azeglio | American Banker, July 6, 1984 | Go to article overview

Bank of Italy Grapples at the Steering Wheel through the High Winds of Public Deficits


Ciampi, Carlo Azeglio, American Banker


The highlights in the world economic picture in 1983 were the vigorous recovery in the United States, its spread to other industrial countries, and continuing stagnation in most of the Third World.

Prudent conduct of economic policy and, in a number of countries, continuing wage restraint, made possible a further deceleration of inflation.

The aim of Italian monetary and exchange policy in 1983 was to curb inflation and support an economic recovery compatible with the state of the Italian economy. The policy of gradually reducing interest rates and the guidelines applied during removal of the ceiling on bank lending maintained orderly conditions in the money and financial markets. This ensured that stimulus from domestic demand would not prematurely augment that stemming from exports, which would have jeopardized the return to balance-of-payments equilibrium and the slowdown in inflation.

The reductions in the official discount rate went as far as was possible in bringing down the cost of money by this means. The high public sector borrowing requirement -- the actual size of which is still fraught with uncertainty -- and an excessive rise in domestic demand could create strains in the financial markets, which would inevitably affect interest rates.

To abandon monetary austerity would jeopardize the gains that have been made on the inflation and balance-of-payments fronts. If the opportunity for lasting growth is not to be missed, the work of correcting the imbalances and inefficiencies that fuel inflation will have to be continued with determination. Public Debt Increased

In the last four years the domestic public debt has increased at an annual rate of 25%, rising from a 48% to a 60% share of all financial assets.

Interest rates peaked in 1981 and then remained at a high level. Maintaining

positive real yields on securities increasing financial saving, thus limiting the effect of the public sector deficit on spending and making it possible to absorb some of the excess liquidity in the economy.

Positive real interest rates are normal in an economy with balanced growth, and in the past they have not been an obstacle to sustained investment.

Exceptionally high interest rates are an inevitable feature of periods of monetary stabilization. The more deeply rooted inflation expectations are, and the less budgetary and incomes policy contribute to stabilization, the higher will be the cost of adjustment.

Moreover, it the real interest rate remains above the growth rate of the economy for any length of time, the progressive increase in the public debt in relation to GDP may prove incompatible with the economy's saving capacity.

At a time when the size of the budget deficit and the difficultly of controlling its growth rendered the independent conduct of monetary policy both more necessary and more arduous, the progress made towards better control over central bank financing of the Treasury, by eliminating its underwriting function, was of fundmental importance both in principle and in practice.

Reaffirmation of the principle that monetary policy should be separate from management of the public debt was accompanied by innovations in funding the borrowing requirement designed to facilitate sales of securities in the market and improve control over the monetary base. Lending to Intermediaries

In these circumstances, in which the Treasury seeks to meet its needs in the market and a greater proportion of monetary base is being created through market operators, central bank lending to financial intermediaries in the form of advances and repurchase agreements is again becoming an important means of regulating liquidity.

Only a few days ago the international legal dispute triggered by the failure of Banco Ambrosiano, one of Italy's largest banks, was settled with the signing of two agreements. The first was between the liquidators of Banco Ambrosiano and the creditors of the Luxembourg holding company and its foreign subsidiaries; the second, between the above and Istituto per le Opere di Religione (IOR), the Vatican bank. …

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