At the origins of the Italy's public debt

Abstract

The Italian public debt is one of the largest in the European Monetary Union and its ratio debt/GDP is the second highest among the Monetary Union countries. A legitimate question is: why Italy has got the most important debt in the euro area? Until the beginning of 1980s the debt to GDP ratio remained within acceptable limits. The Italian debt trend shows a sharp increase in the beginning of 1980s in connection with a new policy of debt financing agreed between the Bank of Italy Governor and the Ministry of Finance in 1981 (the so called “divorce”) and fully implemented in the following 2-3 years. This paper aims to understand if the overall debt increase is related to the dynamics of interest or that of social expenditure, as argued by many scholars. The causal relationships were analysed by testing Granger-causality on long time series of data starting from 1960. A sample including series coming from National Accounts is utilised in estimating our models. The empirical results generally confirm that interest payment was the main driver of debt increase before the European monetary union was established, even assuming that interest policy responded to exchange rates and inflation.