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Crowding out risk: Sovereign debt, banks, and firms’ investment in Italy

Pierluigi Balduzzi, Emanuele Brancati, Fabio Schiantarelli, (2018), “Crowding out risk: Sovereign debt, banks, and firms’ investment in Italy”, VoxEU, 9 Νοεμβρίου

In its budget draft, the Italian government has decided to pursue an expansionary fiscal policy, increasing the deficit to 2.4% of GDP in 2019 and maintaining an expansionary posture for the following two years. The bulk of the deficit increase is due to a minimum universal income scheme and a decrease in the retirement age, although some funds are also allocated to infrastructure investment spending. Even though tax cuts are also included, the increase in welfare spending is the centrepiece of the fiscal expansion. With government debt at 130% of GDP, this budget draft was rejected by the European Commission as it conflicts with the objective of a structural budget surplus and the reduction of the debt-to-GDP ratio.

The fundamental economic bet is that the fiscal expansion will lead to enough economic growth to keep the debt-to-GDP ratio under control and put it on a downward path. Whether this will happen or not depends on the size of the fiscal multipliers (see Ramey (2018) for a review; see also Alesina and Ardagna 2010). Concerns have been raised about the composition of the fiscal expansion, and on the fact that its reliance on welfare spending is unlikely to make it growth enhancing. We focus, instead, on the potential negative effects on private investment. Specifically, we use recent microeconometric evidence on the 2010–2012 sovereign debt crisis to investigate the crowding outof private investment. This is a key issue, as private investment is the most volatile component of GDP, and long-run growth depends on productivity-enhancing capital investment.

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