Reviews | Britain replaced Italy as Europe’s problem economy

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Earlier this month, pessimists on the lookout for the next financial crisis in Europe pointed the finger at Italy. As the pessimists predicted, Italians elected a populist coalition led by the post-fascist Italian Brothers party. But a funny reversal happened. The Italian economy seems temporarily stable. Britain has become the weak power in Europe.

Which give? Intellectual fashion has been bumping up against globalization for several years, so it’s easy to miss the answer. But the Italy-Britain inversion underlines an old lesson. Sacrificing some sovereignty and submitting to the rules of international organizations are not necessarily bad things. If the rules work reasonably well, that can be an advantage.

Despite the scrapping of the responsible government led by economist Mario Draghi, and despite its replacement by an unsavory populist coalition, Italy is in reasonable shape thanks to the European Union. As loudly as the populists used to denounce Europe’s Germanic orthodoxy, they now promise to implement the economic plan drawn up by Draghi and endorsed by the EU – not least because it comes closely together $200 billion in post-pandemic recovery aid for Brussels.

Italian populists also want the European Central Bank in their corner. Over the summer, fearing another eurozone crisis triggered by price shocks from the war in Ukraine, the central bank created a bond-buying program to protect faltering countries from short-selling. hedge funds. To retain access to this support, Italy must avoid crazy policies.

In short, this is not the Europe of a dozen years ago. Rather than reacting belatedly and reluctantly to signs of stress, the continent is trying to anticipate problems. Italy has deep structural fragilities, ranging from demographics to debt, and a lot could still go wrong. But for now the smart money is on its stability.

Meanwhile, having left the EU and never having been a member of the eurozone, Britain is in the opposite position. The new Conservative government led by Premier Liz Truss faces almost no constraints. She was expected to be bold. She turns out to be crazy.

The first sign came with his response to soaring natural gas prices. To protect low-income Britons from the choice between heating and food, Truss had to pay subsidies. But she opted for a monstrously expensive remedy, trampling on her party’s reputation for fiscal prudence. Truss grants must last for two years. They are especially generous to the wealthy. By the UK government‘s own estimates, they will cost more than $60 billion over the next six months, or 4.7% of GDP over the period. Due to their design, they will end up costing even more if natural gas prices rise again.

Megan McArdle: The era of budget gifts is over. Britain’s tax cuts have to be paid for, one way or another.

But that was just rehearsal. On Friday, in a Reagan bid for higher growth, the Truss team announced a ruinous package of unfunded tax cuts. He did so despite the obvious danger that the stimulus package would add to inflation, which is at 9.9% and expected to rise. It did so despite the impact on Britain’s national debt, which is expected to reach 90% of gross domestic product in 2024-25, from 75% before the pandemic. And he did so without allowing the government’s Office of Budget Responsibility to model the impact of his giveaways.

Unsurprisingly, financial markets panicked. Interest rates on two-year government bonds hit 4% from 0.4% a year ago, adding to the government’s debt burden. The pound fell 3.4% against the dollar late Friday, its biggest drop in two years. Over the weekend, Finance Minister Kwasi Kwarteng signaled he could cut taxes further. The pound quickly fell another 4.7% as Asian markets opened on Monday, briefly falling to its lowest level since the floating currency system began in 1971. The pound then rallied on hopes that the Bank of England would intervene to stabilize it. When the bank announced that it would not hold an emergency meeting, the currency fell again.

Why did the Bank of England disappoint traders? It only has a modest stock of foreign exchange reserves, so it cannot support the pound by stepping in to buy a ton of it. Its only option is an emergency interest rate hike, on top of the 0.5% it delivered last week. This would help the pound and, by lowering import prices, would slightly limit inflation. But higher interest rates would drive the economy into a ditch and increase the cost of servicing the national debt. Given Team Truss’ reckless bent, they could go after the central bank and undermine its independence.

When the Brexit referendum damaged Britain’s access to its main export market, economic punishment was inevitable. But this is the first time that being in the monetary union has seemed more attractive than being outside it. The European Central Bank is in a much stronger position to fight the crisis than the Bank of England.

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