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Bad-boy Berlusconi

29 September 2011 By Neil Unmack, Hugo Dixon

The European Central Bank is treating Berlusconi like a naughty boy. A letter from Jean-Claude Trichet and Mario Draghi, the central bank’s current and future bosses, in August told Italy’s prime minister how to run the country’s economy. The implied but unspoken carrot was that the ECB would buy Italian bonds – which, indeed, it did. Given that Berlusconi hasn’t done all he was told to, it’s no surprise that bond-buying has dropped off.

The rough contents of the letter have been suspected since early August, but the detail and precision of its contents will startle Italians. The letter sets out the measures that must be taken – mainly spending cuts, not revenue increases. It demands reforms to the labour market and pensions, insists that it be easier to fire public employees, suggests cutting their wages, and says all of the above should be ratified by parliament by the end of September.

Although having policy dictated from Frankfurt may be humiliating, it is a consequence of Berlusconi’s failure to get a grip on the situation earlier. Some discipline is now being imposed by the bond market. But the ECB had to supplement the stick of the market with the carrot of bond buying because it is worried about contagion.

The snag is the ECB can lecture and reward, but only Italian politicians can implement policy. The austerity budget was brought forward, but Italy has hardly complied to the letter; two-thirds of the austerity measures passed in early September are based on revenue increases, not spending cuts. And the deadline of the end of September for many credible fiscal and structural reforms will be missed.

The ECB seems to be calibrating the size of its carrot to how far Berlusconi goes. It bought just 4 billion euros in the week ending Sept. 21, compared with 22 billion euros in the week ending Aug. 12, and Italian bond yields have nudged up from 5 percent to near 6 percent. Until Italy comes up with a second package of reforms and privatisations, the ECB should keep the pressure up.


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