Italy’s Fiscal Constraints Go Beyond Europe’s Deficit Rules

Italy failed to bring its budget deficit below 3 per cent of gross domestic product in 2025. It therefore cannot exit the excessive deficit procedure, as had been hoped.

Europe is the first to be blamed, statisticians second. That, in essence, is the political debate that has followed the news in recent days.

There is nothing surprising about this. A scapegoat is always convenient. And Europe remains a favourite among many politicians and commentators.

Europe stands accused on several counts.

The first is excessive rigidity. Italy’s deficit in 2025 was 3.08 per cent of GDP, rounded to 3.1 per cent. Since the target was missed by so little, the argument goes, the EU could, indeed should, have turned a blind eye.

Yet European fiscal rules have been applied consistently to all countries for 30 years: a deficit is considered “excessive” if it exceeds 3 per cent.

Everyone who has held responsibility in government, starting with German finance minister Theo Waigel, who had to put together a last-minute fiscal package at the end of 1996, knows perfectly well that “what matters is having a two before the decimal point”.

Flexibility does exist in European fiscal rules and has been used in the past. It concerns the exclusion of certain spending items from the deficit calculation, rather than the 3 per cent threshold itself. But such flexibility must be agreed in advance, not applied retrospectively once the target has been missed.

Europe is also blamed for failing to suspend the Stability and Growth Pact in the current crisis. Here, too, suspending European rules is possible and has happened before, for example during the pandemic. Suspension is, however, subject to specific conditions, particularly concerning the macroeconomic environment, to prevent manipulation.

Despite geopolitical tensions and rising energy prices, Europe’s economy continues to grow. Italy’s economy is currently growing faster than expected, and unemployment is at a record low. In these circumstances, calling for the pact to be suspended means sacrificing political credibility.

The third charge against Europe is that it prevents Italy from pursuing fiscal stimulus until it exits the excessive deficit procedure.

Once again, this reflects a failure to understand European procedures.

To begin with, a country is neither expected to halt fiscal consolidation once its budget deficit falls below 3 per cent, nor would it be desirable for it to do so, especially if debt remains high.

The multi-year path Italy negotiated with the European Commission and the Council of the European Union requires net expenditure to continue falling as a share of GDP, until it ensures a reduction in the public debt ratio of at least one percentage point a year.

This means that the primary budget balance, which excludes interest payments on the debt, must continue to improve in the coming years, as envisaged in the economic and financial policy document the government presented last year.

Countries with deficits below 3 per cent can increase certain spending without it being counted for the purposes of the excessive deficit procedure. But these are targeted outlays, particularly on defence and energy investment, which must ultimately still be financed by issuing government bonds on financial markets.

From the markets’ perspective, what matters is not just the European procedure but, above all, the trajectory of Italy’s public debt, the highest in Europe. Experience shows that when the deficit falls, as it has in recent years, the spread between Italian and German government bonds narrows.

When the deficit is expected to rise, as it was in 2018 under Giuseppe Conte’s first government, a coalition of the Five Star Movement and the League, the spread widens.

In these circumstances, reversing the efforts of recent years and allowing borrowing to rise again in 2027 would cause serious concern, as illustrated by the spread’s rise towards 100 basis points in recent days.

In short, anyone who hoped that leaving the excessive deficit procedure would open the door to an expansionary budget was living in a dream world.

The other scapegoat for Italy’s failure to exit the procedure is Istat, the national statistics institute. Its offence was to revise upwards its GDP estimates for the past decade following a methodological change adopted at European level.

If a similar revision were to take place in a few years’ time, some have argued, we might discover with hindsight that the budget deficit, measured against the revised GDP figure for 2025, had been below 3 per cent, and that Italy should have exited the excessive deficit procedure earlier than it did.

Yet this argument appears to contradict the laws of mathematics, particularly the way the value of a fraction, such as the deficit-to-GDP ratio, changes when its numerator and denominator change.

As Luciano Capone clearly explained in a recent article in Il Foglio, bringing the deficit-to-GDP ratio below 3 per cent would require an upward revision of around 6 per cent to GDP in 2025. That is hardly a realistic prospect.

The reduction in Italy’s deficit is good news, even if it is not yet enough to allow the country to exit the excessive deficit procedure. It should encourage greater progress next year, without looking for shortcuts or blaming others..