Italy is the 8th biggest national economy in the world and the 3rd biggest in the Euro zone after Germany and France. Although it holds the third-largest gold reserves in the world, enjoys a high living standard with comparatively low private debts and is technologically innovative, as for example the recent takeover of parts of the U.S. car industry during the financial crisis 2008-11 underscored, it is currently considered to be the most vulnerable national economy threatened by the European debt crisis because of its huge public debt which reached 118% of the GDP in 2011. Although Italy is considered as "too big to fail" because it could hardly be saved by the European rescue funding programme with a GDP of more than 2.1 trillion Euro, there are fears that a further loss of trust by the international money markets could trigger an unprecedented crisis. Interest rates payed for Italian public debt rose to record numbers in fall 2011 due to the downgrading by leading rating agencies since summer 2011. The seminar gives a concise overview over the current state of affairs in Italy, including its debt and economic crises, and discusses their potential interweavement with the social crisis the country is undergoing in the view of international observers. In the age of media democracy, contextual political factors like social and cultural psychology, public appearances and symbolic events are increasingly impacting Italian politics and economics in ambivalent ways.

A podcast of this talk will soon be made available.

Ronald I. McKinnon is an applied economist whose primary interests are international economics and economic development-with strong secondary interests in transitional economies and fiscal federalism. Understanding financial institutions in general, and monetary institutions in particular, is central to his teaching and research. His interests range from the proper regulation of banks and financial markets in poorer countries to the historical evolution of global and regional monetary systems. His books, numerous articles in professional journals, and op-eds in the financial press such as The Economist, The Financial Times, and The Wall Street Journal reflect this range of interests.

Event Summary

Professor McKinnon first outlines the two major assumptions behind his paper (available on this page). First, that from December 2008 to August 2011, an inflow of "hot money" to emerging economies resulted from low U.S., European, and Japanese interest rates. Since then, the trend has reversed in the wake of the European banking crisis and bank lending has fallen. Second, the dollar remains the widespread central bank reserve currency despite instability in the U.S. system. 

McKinnon voices concern about Federal Reserve Chairman Ben Bernanke's zero interest rate policy, calling it an overreaction to the crisis and a "lose-lose" policy as it deters investment in the U.S. while simultaneously spurring destabilizing hot money flows to surrounding emerging markets. These countries are in turn forced to suppress interest rates to mitigate the inflows, and to build up dollar reserves to keep exchange rates in check. The zero interest rate policy also stimulates carry trades in commodities by speculators.

The belief that under a zero interest rate regime, inflation will stimulate the economy by bringing real interest rates to negative levels, is misplaced in McKinnon's view. He argues that this simply adds uncertainty and interferes with efficient bank intermediation, as banks hold high excess reserves and tighten lending, causing a procyclical contraction as has been seen in the United States and Europe. He contrasts this approach with China, which stabilized its economy following the “dot-com” bust by expanding rather than contracting bank credit. He criticizes U.S. pressure on China to appreciate or float its currency, asserting that these strategies would fail to reduce China's trade surplus.

McKinnon suggests that international reforms should target interest rates instead of exchange rates.  He recommends coordination between central banks of the major industrialized countries, especially the United States, European countries, and Japan - to collectively raise interest rates to approximately 2%. This would improve overall bank intermediation, and would benefit both central and peripheral countries in Europe.

A question and answer session following the talked addressed topics including: the likelihood of a coordinated effort between central banks; the potential effects of Kucinich's monetary reform proposal; the potential negative effects on real growth from carry trades, and whether this is a cause for concern; and the effects of bank borrowing trends in Europe on the European monetary system.