Untying this Gordian knot may now require key decisions on two fronts. First, the ECB could usefully signal the importance of renewing growth with a policy rate cut, even though monetary transmission problems remain unresolved. Second, the Eurogroup could affirm that the fiscal adjustment already in place has brought Italy close enough to structural fiscal balance and that this will suffice as long as tax cuts or new spending are offset going forward. An important amendment to this would be to allow additional public investment, not offset by other measures, equal to realized privatization receipts. This would incentivize action to fulfill the Monti government's plans to realize 1% of GDP a year from sales of utility stakes and real estate. Realized receipts would keep such investment outlays from adding to borrowing and debt. Assuming an expenditure multiplier equal to one, the additional investment would add 1% to GDP and 0.5% of GDP to tax revenues while reducing the debt/GDP ratio by 1.7-1.8 percentage points a year from what otherwise might have been.
Ways must still be found to prod Italy to move on overdue labor market liberalization. But action to boost near term growth would help Europe to sustain the popular backing necessary to advance the reforms needed for the longer term.

Jeffrey Anderson is SENIOR DIRECTOR IIF
janderson@iif.com

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