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December 2006, No. 233

Many authorities at home and abroad questioned Italy’s ability to meet the strict criteria to join the European Monetary Union. The author looks at the interaction between fiscal policy and monetary policy in Italy between 1992, when it exited the European Exchange Rate Mechanism, and 1998, when an official announcement was made that it would join the union.

Last Updated: 11/15/2006

Fiscal Policy and Price Stability: The Case of Italy, 1992–98

Marco Bassetto

It is widely recognized that all episodes of high inflation across the world were accompanied by rapid money creation on the part of a central bank. At the same time, most of these episodes occurred in countries that faced serious fiscal imbalances. The central banks of these countries caved in to the needs of the fiscal authorities, because of either political or institutional constraints. In this Chicago Fed Letter, the author looks at the interaction between fiscal policy and monetary policy in a somewhat different case, one in which the central bank consistently experienced a high degree of independence and no fiscal crisis occurred: namely, Italy between September 1992, when it exited the European Exchange Rate Mechanism (ERM), and May 1998, when an official announcement was made that it would join the European Monetary Union (EMU).