For now, I have three observations about the Italian election outcome. Firstly, perhaps somewhat oddly, I find the outcome quite exciting because it seems to me for a country who’s GDP has basically not changed since EMU started in 1999, something big needs to change. Maybe this election outcome and the peculiar mass appeal of the Five Star movement could signal the start of something new? Secondly, for the established elite of Italy and, crucially, the other ‘power centres’ of Europe, in particular Berlin and Frankfurt, these results are pretty close to a nightmare. Indeed, it questions many aspects of the status quo, including the widespread view in such circles that debt reduction for the sake of debt reduction is not only a worthy cause, but one that is necessary to attract policy support. If such a consensus were open to change, they should question this belief but I suspect it won’t come quickly or easily. Thirdly and linked to this, in my view, Italy’s real problem is the absence of economic growth, which has caused debt to rise, and not the same problems as some other problematic Euro-zone countries. Italy’s cyclically-adjusted fiscal position is actually in modest surplus (see table below), which is better than virtually all other developed countries. I believe that tightening fiscal policy for the sake of it with a vague aim of debt reduction is not a smart strategy. Italy needs to reform its product and labour markets, boost nationwide productivity and reform. They also need German and ECB support in order to stay in the EMU, and especially now, to stop a potentially fresh escalation of unnecessary increases in bond yields. In Italy, reform doesn’t equate to austerity as their voters have just shown.
Jim O’Neill — Goldman Sach