What Would Be The Consequences On The Italian Economy If They Were To Abandon The Euro Currency And Re-Establish The Lira?
There has been a believable rumour that Italy is at the verge abandoning the Euro for its local currency, the Lira. There arise many questions as to why such a developed country with a high GDP per capita would embrace such an idea and the implication of the same to the Economy.
This informing paper clearly sets out all the possibilities that are likely to occur based on previous example of abandoning a currency as well currency areas.
Previously countries have abandoned their currencies for new ones due to varying question with the famous one being the gold standard which the U.S.A and Britain among other nations defected from and created their own local currencies.
Revisiting the history of the Euro, European union was founded in 1957 under the name Rome treaty as Italy one of the leading economies proposing and supporting the unification of Europe as one political block further more one of the famous Italian economist Tommaso Padua schioppa was in the frontline in the founding of the Euro currency and thus Italy can be seen to have been in the lead supporting the formation of a currency area. Why then has it abandoned the child, Euro currency area, it midwife with insanely admirable passion. The Euro currency was officially launched for use in the year 1999 and has continued to be used in the member states as an acceptable medium of exchange with some states agreeing to abandon their initial local currency for the euro after they realised they would benefit from the highly valued currency unlike their weaker currency but this was short-lived as it divided the block into two regions, with one region being favoured with the other being adversely hurt as depicted in the discussions below.
There are critical problems that are associated with the countries at the periphery that has necessitated the exit of Italy from the Euro currency area.
Before a preview of what would happen to Italy if it abandoned Euro for Lira, it would be better to have an understanding of the problem of the Italy at periphery.
- Italy has suffered much external debt of which it has been unable to pay over the years from the time they agreed to subscribe to the Euro to date and the debt have been accumulating over and over and this is likely to drive the economy into a long term crisis as it tries to counter against the accumulating debt.
- Another notable factor is that prices and wage rates of the economy have been going high and high unlike in other countries in the core where prices and wages cost are relatively low and stable.
- Italy has been forced to a situation of being uncompetitive compared to other countries in the core and thus it might be experiencing and witnessing its downfall out of a treaty it orchestrated.
- According to report reviewed by a bank of America, Merrill lynch, Italy has also experienced low bond values and thus weakening its capital market and indirectly affecting its financial market and this has led to increased outflow of the much desired capital to assist tin settling the external bills.
- Merrill lynch has also added that Italy has also faced increased competition in the export arena and being constrained by Euro the fiscal and monetary policy it competitiveness has being poor.
- Another key factor is that Italy lacks fiscal and monetary independence that would allow it to handle its individual economic problem at local level and thus the Euro currency area remains a yoke that denies Italy the much freedom of self adjustment for it to develop economically and respond to economic shocks.
- Another key problem is the inability to print the currency, Euro they are using in their transaction as this is the sole role of the Euro central bank and thus the country remains in constant solvency and liquidity.
In simple terms this means that Italy exits the Euro currency area and then a couple of consequences follow. According to the famous Economist and Nobel Prize winner Robert Mundell threats of exit will always arise in a currency area if the area fails to exhibit the four key characteristics of an optimal currency area which include the following,
- The economies or countries in the currency area must be experiencing business cycles at the same time without any lagging or leading to avoid creation of disparities in the economies, this is not always the case with European Union.
- Prices and wages should move downward and not only upwards this is the opposite with the European union case, Italy whose situation has been worsened by ever increasing prices and wages while in Germany prices and wages are relatively low and stable this creates an economic block that is homogeneous and this becomes the cause of the threats of exit.
- There should be free mobility of labour and capital within the economies this completely fails due to varying degrees of development in the countries as well as varying cultural barriers as well languages which restrict such fee mobility.
- There should also be some aspects of fiscal transfers with the economies in the currency area whereby countries that are doing well can assist those which are performing worse to assist those which are doing better in order to avoid disparities, this is unlikely to happen since countries in the Euro currency area are visioned for individual development and its impossible for such kind of assistance to flow from Germany to Italy or any other country.
The above canons of an optimal currency area as were listed by Robert Mundell in early 1960s even before the establishment of the Euro are what have held the U.S.A region together since all the states, experiences the business cycles coherently there is free mobility of resources from one state to another as well as flow of fiscal assistance from well performing states to poorly performing ones and thus there is uniform progress of the block without notable disparity that would create threats of seceding.
In addition to Roberts’s observation, similar cultural and language background are critical in holding a currency area together, this has also contributed to the prolonged existence of U.S.A as an economic block and thus it’s true that the Robert Mundell claims are true and applicable with reference to the European union and the U.S.A cases.
There are several things that would arise if Italy abandons the Euro currency for its local currency the lira which include the following;
- According to Vittorio Tommasano this would lead to termination of contracts earlier entered into using the euro currency as there would be violation of terms of the contracts but this might not be the case always as there is a room for negotiating on the terms and re-adjust the terms to accommodate the terms under the newly adopted currency.
- The economy will suffer the devaluation of its bonds and other assets since its currency will obviously be weaker unlike the Euro currency in the initial stages and this would investors to transfer their portfolios from Italy to other countries and thus adversely affecting the capital and financial markets of Italy.
- Crisis would also arise in the process of defecting from the Euro currency area since the treaty provide for entry but it did not create the appropriate measures for exit and thus there would be a lot of legal process for the country to follow before achieving its core objective of being economically disintegrated.
- According to Andrew Rose Italy may default in paying public debt since it had earlier taken the debts using the Euro currency which it no longer uses but this might not be the case since there will be a prevailing exchange rates will allow for the loan to be expressed in the current currency in operation and thus the loan will not lose its value neither will defaulting take place.
- Italy would also experience a lot of hard times trying to adopt their lira as well as cash introduction as this will require an overhaul of their banking system reestablishment of their central bank as well as adoption of new fiscal and monetary rules to guide their related policies.
- In the process of defecting from Euro currency area Italy will obviously claim its own share of the European central bank since it owns a stake there and going by the huge deficits tied to Italy there would be a critical crisis between the remaining countries and Italy on how its share would be identified and transferred to it.
- There would also arise a crisis of Italy being evicted out of the larger European Union if it insists on defecting from the Euro currency area which would constrain international relationship with other countries in the union.
- The economy would also experience high levels of inflation since it would be devoid of monetary and fiscal policies which are crucial in regulating of inflation, more so the country would experience massive collapse of many business previously operating under the euro rules and currency and would not survive the window period between switching the currency and rules.
- With Italy being one of the largest contributor to the European union its exit would signify the start of collapse of the European union and thus would later be associated with the inception of the union which was established to stand the test of time and circumstances and thus tainting its reputation more so it will be seen as an economy that is guided largely by self interest. This exit will also cause the country to experience sour international relations with other countries will to remain in the union.
Unlike the predicted suffering that would befall Italy there are also some aspects relief that would come along with seceding, like it happened to those countries that defected from the gold standard they experienced exponential growth both in GDP per capita and low levels of inflation, in relation to this comparison Italy would be in a better position to settle it huge debts but this might not be the case since a success somewhere doesn’t translate to an equal success somewhere else furthermore at the time of exiting gold standard those countries were less developed and thus had a big room and chance to move to higher levels of development unlike Italy which is currently far much developed with a higher GDP per capita and thus its room for more developed is certainly small and thus the only benefit would be to attain fiscal and monetary autonomy.
Italy would also be in good position to compete perfectly when out of the euro currency area with other countries in the union and rest of the world and thus reclaiming its competitive grounds unlike being in the currency area.
It has been qualified that if exiting the union remains the only resort that would facilitate the economic position of the Italy in terms of revitalising its capital and money market as well as settling its huge financial debt as well as attracting more capital inflows then it can follow the suit on advise that it should take all caution to not to cause harm to businesses, investors and other Nations remaining in the union and those indirectly tied to the union. There absolute reason to believe that italy will choose to depart the
Euro for its lira and this remains the only path for other countries in the periphery, default. In fact, exiting the euro currency is the best thing that could happen to Italy and other countries in the periphery since their bitter gain is only financial suffering!
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