Energy crisis, economic growth and public finance in Italy

Italy is the third-largest economy in the European Union after Germany and France. Italy has also the second-highest government debt-to-GDP ratio in the EU after Greece. The 2007–2008 Global Financial Crisis first, and the Covid-19 crisis after, have severely weakened its economy, and further deteriorated its government finance. The recent surge of inflation, due to the rising energy costs in 2022, has had an immediate negative impact on the Italian economy. Could the energy crisis also have profound, long-run effects on the Italian economy, threatening the long-run sustainability of both its government debt-to-GDP ratio and economic growth? This paper assesses the impact of the energy crisis on the Italian economy through a medium-scale stock-flow consistent macroeconomic model. Through a rigorous accounting framework, the paper captures the effects of the changes in energy costs and the feedback mechanisms on both real and financial variables, evaluating some of the policy response available to policy authorities in the EU and Italy. The main conclusion of the paper is that the Italian economy is on the edge of a precipice. The soft landing scenario will bring a low inflation environment, but modest growth and dire public finance, which may trigger punitive EU policy measures. The hard landing scenarios may succeed in containing inflation or bringing the government deficit to GDP ratio in line to EU rules, but at the price of a severe recession and a ballooning government debt to GDP ratio.