Today in Euromess: The least-bad option for Italy

at 05:12 PM ET, 11/10/2011

(Tony Gentile - Reuters)
After weeks of dire warnings about a euro collapse, Thursday felt a little less like doomsday. Italian bond yields have slipped back down below 7 percent. Greece has settled on a new prime minister. And, in the United States, stocks rallied as immediate concerns about Europe eased.

Few economists are ready to predict an easy end to the European debt crisis. “It’s very difficult to see happy outcomes,” says Desmond Lachmann, a former deputy director of the International Monetary Fund. But some do say that a least-bad outcome is at least possible.

The first step would involve increasing stability in Italy. “The best case scenario is that Italy gets a government of national unity that’s committed to working to fix their budget problems,” says Lachman. “That’s looking fairly probable.”

A more stable Italian government would, in turn, make it easier for the European Central Bank to become involved. As Brad wrote earlier today, the ECB has many reasons to be hesitant about swooping in to bail out Italy. Some of those concerns could be quelled, however, if the central bank was assured of dealing with a more stable, credible Italian government. “A new government, with a new plan, makes it a lot easier for the European Central Bank to buy Italian bonds,” says Tom Gallagher, a monetary policy specialist at the Scowcroft Group. And that should give Italy some breathing room as it figures out how to address its fiscal problems.

But even if Italy gets a small reprieve, a stable government and ECB backing still can’t solve all of the country’s budget challenges. “The most they can do is kick the can forward,” says Lachmann. “My fear is that Italy becomes a repeat of Greece.” Slow growth rates and additional austerity measures could just exacerbate Italy’s debt woes. Even if everything goes right in the coming weeks, that’s still just a short-term solution.

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