Italy’s Pre-Maastricht Days

May 17, 2018

A headline in today’s Financial Times reads “Italy’s populists pine for pre-euro times.” The recently established Five Star party and the right-wing League have been trying to form a government, and they have been openly considering desired measures to modify their relationship with other members of the European Monetary Union. The Maastricht Treaty signed in February 1992 set out the rules and transition process by which several European currencies merged into one, the euro, at the end of 1998. Countries that met all the criteria for joining relinquished sole control of monetary policy to an independent regional bank. The project promised many benefits, some of which that have been realized such as less inflation, lower long-term interest rates, and greater insulation from external shocks. But notably, economic growth in many of the members has been chronically weaker than hoped, and unemployment has been elevated.

Italy is the third largest economy that uses the euro. As the leaders of the League and Five Star would have voters believe, the pre-Maastricht years were the good old days. Don’t believe all you hear. The lira was a troubled currency. Right after the dollar devalued for the second time in 14 months in mid-February 1973, 195.4 lire were worth a single German mark. Some 25-2/3rds years later when the mark and lira, along with nine other charter members of the EMU merged into one, it took 990 lire to buy a single Deutche mark. That represents a 6.1 percent per annum rate of lira depreciation over slightly more than a quarter of a century.

The vastly divergent performances of those two monies wasn’t limited to their external value. The exchange rate merely mirrored an even greater divergence in their internal values, that is inflation. Comparisons of December-over-December increases in CPI inflation, for instance, showed the following spreads during the mid-1970s: 25.2% inflation for Italy versus 5.9% in Germany in 1974, 11.1% in Italy to 5.4% in Germany in 1975, 21.8% in Italy to 3.9% in Germany in 1976, and 14.9% in Italy against 3.5% in Germany in 1977. Long-term sovereign debt yield differential between Italy and Germany were likewise very wide, for example somewhat exceeding 750 basis points at the end of 1977.

The lira’s depreciation didn’t happen uniformly in 1973-99. For the last part of that period in the 1990s, as countries prepared for a single currency by adopting macroeconomic goals that imposed convergence, the mark and lira moved more or less in lock-step. Even in earlier times, the lira’s descent proceeded stochastically, with long periods of calm interrupted by violent sell-offs in Italy’s currency. One memorable one in early 1976 saw the lira plunge around 25% in the space of a few months.

It’s been almost two decades since the mark and lira retired and the euro was born. There’s a tendency with the passage of so much time to remember the good things and forget the bad. Italian voters need to think hard before accepting assertions that the good old days were unambiguously swell.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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