This paper reviews developments in the Italian economy during 1994 with some special attention to some specific issues. It describes trends in the real economy, with special annexes focusing on the outlook for inflation and the response of employment to cyclical and structural factors. The paper discusses fiscal developments, and summarizes developments in the monetary sector. It also reviews empirical evidence on money demand in Italy, and the combination of cyclical and structural factors impinging on the banking system.

Abstract

This paper reviews developments in the Italian economy during 1994 with some special attention to some specific issues. It describes trends in the real economy, with special annexes focusing on the outlook for inflation and the response of employment to cyclical and structural factors. The paper discusses fiscal developments, and summarizes developments in the monetary sector. It also reviews empirical evidence on money demand in Italy, and the combination of cyclical and structural factors impinging on the banking system.

Table 1.

Italy: Selected Economic Indicators, 1987-95

(Percentage changes, except as otherwise indicated)

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Sources: Data provided by the Italian authorities, and Fund staff estimates.

Staff estimates and projections, unless otherwise indicated.

In 1992, break in the series due to methodological revisions in the survey; before 1992 the series is reconstructed by the Bank of Italy.

Excluding workers in the Wage Supplementation Fund.

New series since 1991.

Volumes and unit values are customs basis; trade balance and current account are balance of payments basis.

Growth rate used for target monitoring, i.e., moving average of last three months.

End-of-period.

Period average.

I. Introduction

During 1994, the Italian economic recovery entered gathered pace as well as breadth, as the effects of strong export growth were reinforced by a revival of domestic demand. Inflation reached a 25-year low in July, but signs of inflationary pressures began to re-emerge with the recovery and continuing weakness of the lira. Despite the recovery, there is as yet no sign of a decline in unemployment from its recent high levels.

The fiscal situation continued to be problematic, with the level of public debt approaching 125 percent of GDP. The pause in adjustment envisaged in the 1993-95 medium-term plan turned into a reversal, due mainly to the effects of the recession. The 1994-96 plan, implemented in the 1995 budget, reaffirmed the goal of debt stabilization by 1996, but considerable uncertainty remains: the outturn for the primary balance may be better than anticipated due to the stronger-than-expected recovery, but higher-than-expected interest rates have also hindered plans to stabilize and reduce the debt. Structural issues, notably pension reform, as well as tax reform and expenditure control, remain important elements of the policy agenda. Privatization is another key policy priority, with the goal of reducing state involvement in economic life.

Financial markets continued to be troubled by uncertainties with regard to fiscal as well as political developments, and market interest rates reversed the downward course they had followed since the fall of 1992. Long-term rates declined in April to a spread of 250 basis points over German rates in April; this spread widened with mounting political anxieties, reaching over 550 basis points in February 1995. Money and credit growth decelerated. The Bank of Italy began to place increased emphasis on inflation targets as a criterion for policy, as money demand displayed continued signs of greater unpredictability. The banking system continued to undergo important structural changes, also experiencing cyclically adverse results with regard to volume of intermediation, spreads, problem loans, and capital losses on bank portfolios.

International trade reflected competitiveness gains as well as cyclical developments with a widening current account surplus. Capital movements were dominated by portfolio investment, which was influenced both by international interest rate trends and domestic political factors.

This background paper reviews developments in the Italian economy during 1994 with some special attention to some specific issues. Chapter II describes trends in the real economy, with special annexes focusing on the outlook for inflation and the response of employment to cyclical and structural factors. Chapter III discusses fiscal developments. Chapter IV summarizes developments in the monetary sector; annexes review empirical evidence on money demand in Italy, and the combination of cyclical and structural factors impinging on the banking system. Chapter V covers the external sector, including recent developments and trade policy, with notes on the exchange rate and capital flows.

Italy: Background Economic Developments and Issues
Author: International Monetary Fund