While the turmoil in Italy has died down, at least for now, the issue that set it off is sure to provoke more tumult ahead.

The populist coalition that won the last election had proposed to make Paolo Savona, an economist who has said Italy should have a “Plan B” to exit the euro, finance minister. Sergio Mattarella, the country’s president, vetoed the appointment. After initially insisting on Savona, the anti-euro populists have found a different job for him. Markets have calmed, and the new government is proceeding to form itself.

Mattarella is right that talking about a Plan B undermines the euro, and that the country deserves to have that question front and center in an election before deciding it. But Savona is also right that Italy made a mistake in entering the euro. And while leaving now would be extremely disruptive, the country would be well-advised to have at least a quiet contingency plan for leaving.

Savona overstated matters when he called the euro a “German cage.” It has provided real microeconomic benefits to Italy, as it has to other participating states: lowering transaction costs in its trade with neighbors, and encouraging tourism and investment.

But having a common currency for all the countries in the euro area entailed having a common monetary policy for them, too. That monetary policy has worked out poorly for Italy -- and, yes, better for Germany.

David Beckworth, a visiting scholar at George Mason University’s Mercatus Center, has shown that the European Central Bank’s policies have tended to be a better fit for the countries at the core of the European Union rather than at their periphery. His analysis employs the Taylor Rule, a measure of the appropriate target interest rate for a country based on its inflation rate and the difference between its potential and actual economic output. The ECB’s target rates were much closer to what the Taylor Rule prescribed for core countries than for peripheral ones. Monetary policy was too loose in the peripheral countries during the boom that preceded the economic crisis of 2008-9, and too tight thereafter.

Monetary policy can also be judged based on whether it stabilizes the growth of spending throughout an economy. By this measure, too, the ECB served Italy badly. Before the crash its spending grew faster than Germany’s, and after the crash it has grown more slowly -- and sometimes even fallen. The wild swings are marks of counterproductive monetary policy. Declines in spending are especially damaging. They raise debt burdens and require painful, and typically long, periods of labor market adjustment.

Variation between regions was inevitable. If ECB policy had been perfect for Italy, it would have been destabilizing for Germany.

While specific ECB policies are open to criticism -- it was too tight for the whole region in 2010 and 2011, for example -- the root problem is the common currency itself. And that isn’t something that was imposed on Italians by outsiders. Most Italians, according to polls, want to stay in the euro, perhaps because of its undoubted microeconomic advantages.

For many Italian voters, no doubt, the ideal arrangement would be for the country to continue to reap benefits from the euro while getting unconditional bailouts from other countries. But they are not the only actors in this drama who have inconsistent and unrealistic, though understandable, preferences.

Germany wants to keep both bailouts and inflation to a minimum while sticking with the single currency. Even if the euro muddles through for now, it will generate future crises. Italy should hold an exit plan in its back pocket. So should other countries.


Ramesh Ponnuru
Ramesh Ponnuru is a Bloomberg Opinion columnist. -- Ed.

(Bloomberg)