Italian Consumer Confidence Index

Italian reader Paola wrote in to bring to my attention that consumer confidence just rose in Italy (I had seen this covered by Bloomberg).

Let me first make a linguistic point, the difference between sperare and aspettare. Sperare means to hope, while aspettare to expect (or to wait). I think sometimes we may confuse these two ideas. We try to expect what we hope for (Spanish is even clearer here, since esperar covers the area of meaning occupied by these two verbs in Italian). What I think is that people, and Roberto at Wind Rose Hotel, sometimes finds himself doing this I fear, sometimes mix-up the two. Obviously we all hope for the best for Italy, but hope sometimes is not enough, sometimes we need to apply reason (our rational side), even if emotionally this is hard.

Italian consumers appear to be feeling good. This is welcome news, but as an economist I have to ask myself whether this feelgood effect is sustainable. Looking at the investor confidence indexes in Germany, and the evolution in the housing market in the US, it seems that 2007 is not set to be an easy year.

This is doubly the case for Italy, which will feel the speed reduction in Germany at one and the same time that the Prodi government will be introcdicing a difficult and painful set of spending reductions. In the circumstances my opinion is that the 'feelgood' effect will not last (unfortunately).

To illustrate some of the difficulties we might look at what is happening right now in Hungary. Also of relevance is this comparison made by George Kopits (now on Bank of Hungary monetary policy board) in the WSJ Europe (Thursday -- subs. req'd)) pursuing the Italy-Hungary comparison. Here are the closing paragraphs:


There are, however, differences in the approaches adopted by Budapest and Rome. The new Italian government is composed of a loose coalition of divergent political parties holding only a razor-thin majority. Any initiative to reduce the budget gap through spending cuts (as the government is rightly committed not to raise taxes but even to trim payroll taxes) requires painstaking consultations and negotiations with individual coalition partners. To strengthen his hand, Prime Minister Romano Prodi appointed internationally respected Tommaso Padoa-Schioppa, a former member of the European Central Bank's executive board, as finance minister. Mr. Prodi also named an independent commission headed by a respected civil servant, Riccardo Faini, to shed light on the public sector accounts. In addition, the government quickly passed a supplementary budget to contain this year's deficit and started to deregulate some domestic services. Laudable as they might be, these initiatives are only the beginning of a genuine adjustment effort. It remains to be seen whether the structural reforms the government announced in July will in fact be implemented. The immediate challenge for Rome is to resist calls to water down spending-cut plans for next year, given that revenues are expected to surge due to higher economic growth than previously anticipated.

The re-elected Hungarian government, on the other hand, enjoys a commanding legislative majority. But it needs to overcome an enormous credibility gap, having missed its budget targets by a long stretch five years in a row. Whether the prime minister's leaked confession will boost his credibility or further undermine it remains to be seen. Having contributed significantly to the budget imbalance with a large dosage of creative accounting, the government has yet to persuade financial markets and EU institutions that it will undertake the necessary fiscal reforms. The medium-term budget plan that Budapest submitted two weeks ago to Brussels is frontloaded with a number of apparently improvised measures, mainly tax hikes and one-off spending cuts. And yet, it could provide the starting ground for restoring fiscal sustainability -- if it is beefed up with far-reaching reforms, including an overhaul of generous entitlement schemes.

Clearly, in both countries, the budget programs need to be subject to close outside surveillance. In Hungary, the recently appointed independent "convergence council" should not only issue a candid assessment of the budget program but also play an active role in monitoring its execution. In addition, the European Commission and EU finance ministers should exercise effective peer review of each country's performance. The strict enforcement of the Stability and Growth Pact's fiscal criteria would serve the long-term welfare of these member countries, as well as the interest of the entire EU.

Failure to bring the budgets of these countries under control could have dire consequences. Italy's economy would experience a lengthy period of stagnation, bogged down by a further erosion of its competitiveness. That's because large public deficits tend to crowd out private investments, while distortions from generous welfare payments and high taxes dampen labor force participation and productivity. Prolonged stagnation in Italy would weaken the entire euro zone just when economic growth in the U.S. is about to slow down.

In Hungary, the immediate stakes are far higher. The country could lose EU cohesion funds and its euro accession could be postponed indefinitely. More importantly, Hungary ranks among the countries most vulnerable to a financial crisis if investors decided to pull out en masse. Contagion from a crisis in Hungary to other emerging-market economies (notably Poland and Turkey) would, in turn, be difficult to avoid.

Ultimately, the fiscal drinking habit can be kicked only if the political elites show conviction and manage to garner public support for unpopular measures.

In Italy, fiscal reforms, accompanied by the liberalization of the labor and commodity markets, would help jump-start productivity growth and competitiveness and reduce unemployment. Similarly, in Hungary, strong commitment to fiscal discipline would confer multiple benefits, including entry into the euro zone. Above all, restoring credibility would encourage investment and accelerate real convergence in income levels toward the rest of Europe.