The Buti and Franco's advice

to the new Italian government


Antonio Forte



This short essay is divided into three parts. First, I briefly examine some capitals of the book "Fiscal Policy in Economic and Monetary Union" written by Marco Buti and Daniele Franco.

Then, I use their economic researches to analyse the present Italian economic situation and to show what the new government should do.

At the end, I illustrate three different future scenarios of the Italian public finance.


The analysis of the fiscal rules of the European Monetary Union represents the core of the book written by Buti and Franco.

The need to pursue a sound fiscal budget, an important backbone of the European economic unification, is fundamental not only to reach the sustainability of the public debt and deficit but also to ensure an higher degree of credibility to the entire European Monetary Union system.

The Maastricht Treaty and the Stability and Growth Pact show to the national fiscal authorities the route that they have to follow to get balanced and sustainable budgets.

The Maastricht Treaty (1992) sets two basic targets of this route. The first is the ceiling of the deficit-Gross Domestic Product (Gdp) ratio (settled at 3%), the second is the national debt-Gdp ratio, that should be under a threshold (60%) or it should converge to this limit if it is above this percentage.

The Stability and Growth Pact (1997) sets other important elements and procedures. In this document we can find: the definition of the exceptional conditions that allow governments not to respect the deficit-GDP ceiling; the timing of the excessive deficit procedures; the sanctions for the countries that do not respect the limits.

But it is important to focus the attention on an important statement of the SGP. In the SGP it is written that governments should pursue a "medium term objectives of budgetary positions close to balance or in surplus". The "close to balance or in surplus" position is fundamental to ensure the respect of the deficit-GDP ceiling in period of recession.

Starting from this statement Buti and Franco have analysed the sensitivity of the budget of the EMU members in order to set the appropriate medium term percentage of the deficit-Gdp ratio that these countries should pursue to be able to respect the 3% ceiling even in case of economic downturns without operating any tight fiscal actions.

For instance, they have calculated that Italy "could aim for a deficit even slightly above 1 per cent of Gdp" in the medium term. In this way, if Italy should reach this budgetary position, it will be able to respect the 3 per cent deficit-Gdp ratio threshold even in a really critic economic downturn.

In particular, Buti and Franco set this ratio at 1,2 per cent. Moreover they highlight that this limit of the deficit-Gdp ratio should be lower or should be a surplus if we consider the negative effects of the ageing on public outlay in the long period. Nevertheless the value of 1,2% for the deficit-Gdp ratio will be fundamental in the second part of the essay to compare the situation of the Italian budget in 2005 with this theoretical benchmark.

Another important feature of the book is the analysis of the effectiveness of the different fiscal policy actions. Using the QUEST model Buti and Franco calculate the variation of Gdp in consequence of the use of different fiscal tools (Buti-Franco pag. 72-76). They evaluate the elasticities of Gdp in the short term, after a cut of taxes (labour incomes, corporate profits, value added tax) of 1% of Gdp or in consequence of an increase of expenditure of 1% of Gdp (government employment, government investment, government purchases of goods and services, transfers to households).

These different fiscal multipliers are important to understand how a government could use the tools of the fiscal policy to build a loose or a tight policy in the short term. For instance, a government can increase expenditure for employment to have a short term good response of Gdp. Buti and Franco highlight that, in the short term, Gdp does not have a good response after a cut of the labour income but this type of expansionary policy, as they underline, gives a better outcome in the medium-long term. So, governments can choose between a fiscal policy with an immediate, but with a short breathe, response and a more gradual fiscal policy with long term effects (or they can mix these policies).

It is straightforward to understand that the governments of EMU members should use the tools of the fiscal policy like an acrobat. They can only use the fiscal policy to stimulate the economic growth (the monetary policy is no more a national tool) but, at the same time, they have to respect the European Treaties.

So, in conclusion, if we consider the analysis of Buti and Franco as a whole, we can say that it is extremely difficult to reconcile the respect of the Maastricht Treaty limits and the Stability and Growth Pact recommendations with the necessity to implement a loose fiscal policy or a counter cyclical policy in case of an economic recession.

This is a challenge for the European governments, and especially for the Italian one.


At the end of 2005 the economic and budget situation of Italy was not very good. There was no economic growth (Gdp growth 2005: +0,0%), the deficit-Gdp ratio rose at 4,1% and the debt-Gdp ratio was at 106,4%. This is a critic situation because: 1) the deficit-Gdp ratio is more than 1 per cent above the ceiling of the Maastricht Treaty and about 3 per cent more than the medium term objective; 2) the debt-Gdp ratio has risen for the first time after a decade; 3) the lack of the economic growth makes the whole situation worse.

It is important to underline that, as shown by the economic data published in March by ISTAT, there was an economic stagnation of the Italian Gdp not only in 2005 but also in 2003.

Obviously, in such a situation it is very difficult to respect the European Treaties. But we should bear in mind the faults of the previous government in managing the budget trends (there were also political responsibilities behind the negative fiscal outcomes…).

And thus, the new government should operate to give new strength to the economic growth (and this implies an expansionary fiscal policy) and to respect the european budget ceiling (aim reaching with a tight fiscal policy). A very difficult goal!

Now, we can join the analysis of Buti and Franco over the "medium term objectives of budgetary positions close to balance or in surplus” with the present budget situation of Italy.

We can assume the period of the legislature as a medium term period to reach a budgetary position close to balance or in surplus. Given this hypothesis, the new government should cut the deficit-Gdp ratio from 4,1 to about 1% (the percentage set by Buti and Franco for Italy as the medium term objective for the budget policy is 1,2%).

A route to get this goal could be the one described in table 1.


Table 1



2005* 4,1%
2006** 3,8%
2007** 2,8%
2008 2,2%
2009 1,6%
2010 1,0%
*Datum available on Istat web site.

**Esteems of the Italian gofernment.


The deficit-Gdp ratios set for the years 2006 and 2007 are the ones established in the D.P.E.F. (Documento di Programmazione Economico-Finanziaria) of 2005. These data have been accepted by the European Institutions as a good route to offset the exceeding part of the deficit-Gdp ratio.

In 2008-9-10 I have supposed a yearly cut of this ratio of 0,6%. In this way in 2010 the deficit-Gdp ratio would be at 1,0%, below the percentage that allows the automatic stabilizers to freely operate without exceeding the ceiling of 3% in case of an economic recession according to the Buti-Franco’s analysis.

Given these data of the deficit-Gdp ratios, assuming an inflation rate at 2% (the medium term objective of the European Central Bank) and a growing positive economic cycle (see table 3), it is possible to calculate the variation of the debt-Gdp ratio for the next years.

For this purpose I have used a simple equation to calculate the trend of the national debt-Gdp ratio (Blanchard, 2000, pag. 663):

Dt / Yt = [(1 – p)/(1 + g)] * [(Dt-1 / Yt-1)] + (Gt – Tt) / Yt

Where D is the amount of national debt, Y is the GDP, p is the inflation rate, g is GDP growth rate, G is the state annual total expenditures (it contains the interests), T are the state total receipts and t and t-1 are the temporal references.

Under the previous hypothesis, probably too much optimistic, in 2010 the debt-Gdp ratio would be under the 100% (see table 3), an important economic and psychological limit.

The decrease of the national debt is a primary objective for the Italian fiscal policy. A lower and decreasing debt reduces the burden of the interests, helps the government to respect the deficit/Gdp ceiling and gives more possibility to use the fiscal policy in the short run.

Using the Buti and Franco’s researches it is also possible to examine, in a qualitative way, how to implement a fiscal policy to reach these aims reducing or eliminating its negative impact on Gdp growth (obviously I refer to a tight fiscal policy that typically has a negative impact on Gdp growth).

If we consider the fiscal multipliers of the different tools of the fiscal policy (see Buti and Franco pages 72-76) to operate with the same intensity in case of tight and loose fiscal policy, we can build an optimal fiscal policy.

For instance, in table 2 it is possible to examine a tight fiscal policy of 5.000 million € that does not substantially have a negative impact on Gdp growth.


Table 2

Fiscal tool Hypotetic use of fiscal tool (mln €)* Expenditure and tax multipliers** Impact on GDP***
Employment +3.000 0,9 +0,001905%
Investment +5.000 0,63 +0,002223%
Purchases -8.000 0,62 -0,003500%
Transfers -10.000 0,19 -0,001341%
Labour income tax -5.000 0,2 +0,000706%
Corporate tax 0 0,21 -
Value added tax 0 0,51 -
Total amount of fiscal tools (mln €) -5000   Total impact on Gdp -0,0007%

*Personal evaluation; ** Personal elaboration using data by Buti and Franco, 2005, pages 72-76;***data obtained using the value of Gdp of 2005 (1.417.241 mln €)


This is only a simple example, but it is useful to understand how a government can use the tools of the fiscal policy linking the reform of the fiscal budget and the economic growth together. For Italy it is necessary to reconcile a sound fiscal policy with an increase of the economic growth: it is a difficult objective, but my example shows that it is not impossible.

At the end of this essay I propose three future economic-budget scenarios. The three scenarios are focused on medium term projections.

The table 3 is a sum of the previous hypothesis: a growing economic expansion, a steady inflation rate and a really good fiscal policy. This scenario, as I have written before, leads to a rapid reduction of the debt-Gdp ratio.

The data of the table 4 are based on different hypothesis: I have assumed a deficit-Gdp ratio at 3% for the years 2007-8-9-10. Comparing table 4 and table 3 it is possible to notice the impact on the debt-Gdp ratio of two different fiscal policies: the first one (table 3) is a policy aiming at a medium term budgetary position "close to balance or in surplus"; the second one (table 4) is a fiscal policy that only respect the 3% deficit-Gdp threshold, that is the minimum objective for a EMU member.

Table 5 shows the impact of a supply shock on the budget. I have assumed an oil shock that entails an increase of the inflation rate and a decrease of the Gdp growth rate (in comparison with table 3 and 4), and a not so good fiscal policy (the same of table 4). It is straightforward to observe and to understand the impact of this type of shock on the debt-Gdp ratio.


Table 3 (good Gdp growth, good fiscal policy)

Year Gdp growth Inflation rate Deficit/Gdp Debt/Gdp
2005* +0,0% +1,9% 4,1% 106,4%
2006 +1,2% +2,0% 3,8% 106,84%
2007 +1,4% +2,0% 2,8% 106,05%
2008 +1,6% +2,0% 2,2% 104,50%
2009 +1,8% +2,0% 1,6% 102,19%
2010 +2,0% +2,0% 1,0% 99,19%

*data avilable on Istat web site


Table 4 (good Gdp growth, minimal fiscal policy)

Year Gdp growth Inflation rate Deficit/Gdp Debt/Gdp
2005* +0,0% +1,9% 4,1% 106,4%
2006 +1,2% +2,0% 3,8% 106,84%
2007 +1,4% +2,0% 3,0% 106,25%
2008 +1,6% +2,0% 3,0% 105,49%
2009 +1,8% +2,0% 3,0% 104,55%
2010 +2,0% +2,0% 3,0% 103,45%

*data avilable on Istat web site


Table 5 (supply shock)

Year Gdp growth Inflation rate Deficit/Gdp Debt/Gdp
2005* +0,0% +1,9% 4,1% 106,4%
2006 +0,5% +2,5% 3,8% 107,02%
2007 +0,5% +3,5% 3,0% 105,76%
2008 +0,5% +4,5% 3,0% 102,45%
2009 +0,5% +4,5% 3,0% 99,33%
2010 +0,5% +4,5% 3,0% 96,40%

*data avilable on Istat web site