I heard some confusing — and slightly confused — reporting on television last night to the effect that Italy is not only “too big to fail,” it’s also “too big to save” in the sense that the Italian economy and outstanding debt are so large that Europe “can’t afford” a bailout. That’s wrong.
Here’s the basic outline of the situation. Italy has a large amount of outstanding debt. It also has what’s called a “primary budget surplus,” meaning that if you ignore financing that outstanding pool of debt, tax revenues exceed program expenditures. This means that the state of the Italian budget is heavily dependent on the interest rate it needs to pay on its debt. If interest rates are high, the budget deficit is large and Italy is broke. But if interest rates are low, the budget deficit is low and Italy can pay its bills. So in the short term at least, what Italy needs is not a “bailout” but low interest rates. This is something a central bank can easily deliver if it wants to and there’s no question of not being able to afford it. If you assume the existence of an Italian government with a good-faith desire for debt reduction and a central bank with confidence in the Italian government, you have an eminently solvable problem here. The government agrees to keep budgeting for a primary surplus of such-and-such and the European Central Bank agrees to keep rates down to such-and-such and it’s off to the races.
Those are, of course, big assumptions that I just made there. But the assumptions and the text of the Lisbon Treaty, not “affordability” are what’s at issue. Under Silvio Berlusconi there was no confidence in the Italian government. Without Silvio Berlusconi, there’s no Italian government at all. Whether Italy can produce a stable government with a parliamentary majority in favor of sound budget practices is an open question. Whether the ECB would be willing to extend adequate support even if such a government emerged is also an open question. But those are the issues, not that Europe somehow doesn’t have enough Euros around to pay the Euro-denominated debts that a European government owes primarily to European banks.