Mr. Padoan, in a recent interview, you said that an extreme right-wing government in Italy would not bring any economic disadvantages. What makes you so sure?
I am simply going by what the leaders of the right-wing parties have repeatedly announced: that they will uphold European rules or the European Union, as well as a free market, financial stability and prudence. I think that there is a shared interest in the country that we should not waste the opportunity to strengthen the economy, in spite of the incoming recession, and should therefore implement the “NextGenerationEU” program, which is very generous towards Italy.

Within the last years and months we have seen a cascade of crises – the financial crisis, Euro crisis, pandemic crisis and now the war in Ukraine. How do all these crises affect the economy in Italy and Europe?
Well, they are, of course, affecting the economies in Europe and not only in Europe, because they are generating a huge rise in energy prices, which is a component and also a cause of the return of inflation. And given that the inflation we are seeing is the combination of demand-side inflation and supply-side energy cost inflation, it’s very difficult to fight this kind of inflation. So, we have seen that central banks have raised their interest rates both in Europe and in the United States. Policymakers now use monetary policy to fight inflation. The costs in terms of forfeited growth and employment will be very high. So, I hope that there is a response to inflation which takes on board all the policy instruments, i.e. monetary policy, as well as fiscal and structural policy. That is in addition to energy policy, we badly need an energy policy overview in Europe.

What kind of development do you expect? Hyperinflation? Right now we have stagflation.
Well, this is difficult to answer. Hyperinflation, strictly speaking, is something which has an explosive dynamic.

Like in the nineteen twenties?
Especially if inflation goes over two digits or the 20 % instantaneous inflation, we know from experience that this is the end of currencies. I see hyperinflation in many countries but I don’t think that we will go that far. What we see now is mostly, in my view, a reaction to a price shock, which has hit the energy markets and not just one, but also gas and oil and energy substitutes. So, if it’s a shock and it remains a shock, and does not become entrenched, and does not get passed over to labor markets or to the rest of the economy, then we can hope that this will go away in the short to medium term. If, however, it’s not addressed effectively, it will become entrenched in inflationary expectations in the labor market, which is also under tight pressure because of recent growth. So, there is a potential for further inflation, and this could be very, very, very dangerous. We haven’t seen that sort of inflation for decades in Europe.

Germany is still very addicted to Russian energy, as is Italy. How is Italy going to solve the energy crisis?
Well, the Italian response so far has been based on three stages. First of all, we have to find ways to protect the lower income population from huge price increases, which strike at their capacity to resist poverty. So, we are facing a potentially very serious social crisis. Next step has been to diversify geographically, so to significantly decrease the acquisition of gas from Russia while increasing acquisition from North Africa. And, of course, what we really need in the medium term is to diversify the supply capacity in Italy, in Europe and elsewhere by investing in alternative sources of energy and at the same time accelerating the environmental transformation of the economy, which means, of course, that energy is produced in different ways. So, this needs to be done and needs to be done at the European level because it’s a big challenge not only for Italy.

Pier Carlo Padoan

Do you really expect social protests in Italy and all-around Europe during the next winter?
Well, it depends how bad and how cold the next winter will be. Certainly there is the potential for turmoil in social protest, which is justified. So, we need to anticipate that and avoid social unrest, and also protect the weakest segments of the population.

You’ve already talked about higher interest rates in the United States as well as in Europe. Can Italy or other states like Greece, handle a higher ECB interest rate to fight inflation?
Higher interest rates on national securities reflect higher risks. In Italy we have to face, as usual, the fact that there is a higher risk with respect to other European countries that needs to be addressed. One way forward is to prove that we can grow more. But it would be better if the funds came from Europe so that we could decrease the risk of default. Despite that, the banking system in Italy is now much healthier than it used to be a few years ago. So that decreases the risk of the economy.

How do you rate the German debt brake, the so called Schuldenbremse?
A debt brake is a very powerful instrument, but it’s like a brake in a fast car. If you pull the brake too quickly at high speed, you risk breaking that brake.

Do you see that danger for Germany?
No, I don’t think so. Frankly, Germany has a very low, insignificant amount of debt. It has a fiscal capacity which can stand up to fiscal shocks, although, of course, we are talking about a new situation for the whole of Europe. Certainly, the debt brake is a mechanism which works better in Germany than it would in Italy. My point of view is that in Europe we should find ways, possibly with national features, that altogether generate a decrease of debt to GDP values, because that would boost confidence. It would also help to make progress towards banking union and the Financial Markets Union because it would help diversify risk much more effectively.

Does Europe need a fiscal and a debt union?
Well, if you have a monetary union, a banking union, and a fiscal union, then basically you have all the ingredients for a union, but I would not call it a debt union. It doesn’t sound good, it would not be very popular. Certainly, however, there is a problem of how we deal with the existing stock of debt and how we deal with future debt. I’m saying this because we are moving with due prudence towards the issuance of European bonds, and this requires a different approach to that build-up, which means that instead of not caring about the debt dynamics at all, we have to be more selective and qualitative. And this can be done in a number of ways.

Actually, that is the fear in Germany – that by using eurobonds there will be no mechanism to control debts within Europe and that Germany will be the member state paying the bill.
Yes, but my answer is economic. If Europe has so called public goods, like for instance a common defence system, I would be in favor of having European bonds financing European goods. And that’s why I mentioned before that we have to separate what we do with the existing debt with respect to what we do with future debt. This is the point.

The war in Ukraine has put a lot of pressure on the euro. The exchange rate between dollar and euro is at its lowest level. In view of the excessive debts, not only in Italy, can the euro survive?
Well, this is a question that has been asked for decades, since the euro was launched. What I see is that since the introduction of the euro, the institutional architecture in Europe has become stronger. It has survived a major financial crisis. And now it is surviving the new crisis. This is the way Europe responds to crisis – by strengthening.

Whatever it takes?
Whatever it takes only works if there is credibility in the person who says that, but also knowledge that there are instruments which can deal with such a crisis. We had a major financial and banking crisis more or less ten years ago. During that situation, we were in the middle of a transition towards a new banking regulatory structure because the old one was inefficient, didn’t work well, and generated more costs than it should have – with pain for the population. So, we have learned from that. We are now looking for ways to deal with the banking crisis more effectively. Unfortunately, let me finish with this: The debate on banking union has stalled and this is a source of concern because, if that is really how things are, and let’s hope not, we will have a financial crisis coming down the line in a couple of years. We are still stuck with the old system. And this – as we know – will not work well.

Pier Carlo Padoan is an Italian economist who served as Minister of Economy and Finance of Italy from 2014 to 2018. He held several academic positions in various European cities as well as in Argentina and Japan. From 2001 to 2005 he was director of the International Monetary Fund for Italy. In 2007, he became Deputy Secretary General of the Organisation for Economic Cooperation and Development (OECD) and in 2020 he was appointed chairman of the Board of Directors at Italy's major bank UniCredit. He is a highly demanded consultant for different institutions, such as the World Bank, the European Commission and the European Central Bank (ECB).

Copyright Header Picture: shutterstock