The changing relationship between inflation and the economic cycle in Italy: 1861–2012

Abstract

The article investigates the relationship between GDP and prices in Italy in the long-run, from the country's Unification (1861) up to present day. By using the new national accounts data, over the period 1861–2012, we were able to make Italy the third country to have a historical test of the hybrid Phillips curve (in which both the new Keynesian and the backward-looking Phillips curves are tested), together with the UK and the US. How do economic growth and prices interact in Italy's different stages of economic growth? Unlike the US and the UK, where said interaction was already operating in mid-19th century, in Italy the link between inflation and the economic cycle emerged only after the First World War. We argue that this can be explained owing to Italy's different position in the international economic system and the way foreign conditioning factors (the exchange-rate regime and innovation in transportation) influenced the Italian industrialization. Before the First World War, deflation was imported. This turned out to be compatible with some GDP growth, insofar as the deflationist macroeconomic setting favoured capital inflows and technological upgrading. Whereas, from the First World War until the creation of a common European currency, price variations were mainly a consequence of national policies and domestic conditions: the trade-off with the GDP cycle is now manifest, both in the periods of deflation (the interwar years) and in those of inflation (the second half of the twentieth century). Our findings may also have important implications for present day, since price movements are once again, as in the liberal age, largely imported.