The crisis of confidence has spread from the financial markets to the decisions of consumers and enterprises - After spreading rapidly to the whole financial sector and the rest of the world, in the last few months the crisis that broke out in the summer of 2007 in the US mortgage market has affected the real economy and is now influencing consumption, investment and production choices. GDP dynamics have deteriorated sharply in the leading economies and the emerging countries have also begun to suffer.
The interventions of governments and monetary authorities have prevented even more dramatic developments - With the collapse of the investment bank Lehman Brothers in September and the emergence of fears of insolvency at other intermediaries, concern about the possible collapse of financial systems intensified, world stock indices incurred heavy losses, and a significant and disorderly tightening of credit conditions loomed. Governments and central banks reacted in coordinated fashion at international level, ensuring a continuous flow of funds to financial institutions and the real economy, increasing bank deposit guarantees, and in many countries strengthening the capital of intermediaries in difficulty. Measures of this sort have been adopted in Italy too. This action has prevented the paralysis of financial markets. The risk premiums on interbank loans, which had soared in September and October, decreased between November and December, although they remain at historically high levels.
Cyclical indicators are negative in all the main economies and economic policies are becoming expansionary - The signs of a small and partial easing of financial tensions are counterposed to a rapidly deteriorating cyclical situation in all the main economies. In the United States, where the property market continues to languish, business and consumer confidence has diminished further. The major forecasting organizations estimate that GDP contracted sharply in the last quarter of 2008 and will continue to decline in 2009. Japan is also in recession. In China and India the pace of growth in output is declining. The weakening of economic activity has been accompanied by a brusque fall in the international prices of raw materials, especially energy, and these prices have returned to their level at the end of 2004. This has led to a pronounced slowdown in consumer price inflation in the major economies. According to the leading forecasting organizations, the slowdown in price inflation will continue in 2009, although without turning into deflation. As inflation came down and cyclical conditions worsened, there was a sharp reduction in official interest rates in the United States (where they have been brought down to virtually zero), the euro area and other countries. Important public finance programmes to support aggregate demand are planned or are already being drafted.
The euro area has gone into recession - In the euro area the fall in foreign demand and the crisis of the financial markets had its initial impact on firms' investment decisions. In the third quarter of 2008 there was a further contraction in GDP, amounting to nearly one percentage point on an annual basis. After contracting in the preceding months, in October and November the area's industrial production fell by 1.6 per cent. The €-coin indicator turned negative in November. Business and household confidence are both at historically low levels. There is growing fear of a serious deterioration in the labour market in the year that has just started. The main private-sector forecasters estimate that GDP will contract by more than 1 per cent on average in 2009.
After the coordinated reduction in October, the European Central Bank lowered its reference rates further in its meetings at the beginning of November and December, by 50 and 75 basis points respectively. Short and medium-term inflation expectations, which worsened in the summer as energy commodity prices rose, have fallen back drastically in the last few months.
Italy, too, in recession - Italy's GDP, which fell by 1.6 per cent on an annual basis in the second quarter of 2008, contracted by 2 per cent in the third, reflecting a slump in business investment, a decline in exports and stagnant household consumption. The deterioration in cyclical conditions grew more pronounced in the closing months of the year: the index of industrial production is estimated to have fallen by about 6 per cent in the fourth quarter on a calendar and seasonally adjusted basis. Firms' confidence has dropped to historically low levels; recent surveys of businesses indicate that investment will remain weak during this year, in a context of widespread pessimism over the outlook for demand. After more than a decade of growth, employment ceased to expand in the third quarter of the year; recourse to the Wage Supplementation Fund increased in the final part of 2008.
Bank lending slows - The rate of growth in bank lending remains high but is coming down, reflecting the prudence that the recession has induced in firms' and households' demand for credit. The slowdown in lending is sharper for small firms. In addition, the periodic credit survey conducted by the Bank of Italy signals a progressive tightening of lending conditions; according to other surveys, the percentage of firms finding it difficult to obtain financing is increasing. In Italy as in other countries, banks are adapting their balance sheet assets to the difficulty and increasing cost of funding. The abatement of the strains in the money and financial markets and the capital strengthening of banks, facilitated by the measures taken by the Government and the Bank of Italy, can help to ease lending conditions. The data for the first two thirds of December show that the recent reductions in official rates are gradually being transmitted to bank lending rates.
The general government borrowing requirement and debt are rising - The general government borrowing requirement and debt turned upwards in 2008. Both aggregates increased by approximately one percentage point with respect to GDP. The ratio of the public debt to GDP also apparently rose significantly. Tax revenue was basically unchanged. The impact of the economic downturn on revenue will be felt more strongly in 2009. The budget for the years from 2009 to 2011 approved by Parliament last summer has been supplemented, without substantially affecting the planned balances, by the Finance Law for 2009 passed in December and the decree law to sustain the economy approved by the Government at the end of November. The decree law raises €5.6 billion for 2009 and allocates it to income support for low-income households, tax reductions for firms and stimulus to investment activity.
Economic activity in Italy is projected to fall further in 2009 and stabilize in 2010 - In the six months that have passed since our forecasts for the Italian economy were published in the Economic Bulletin of last July, the global crisis has spread and intensified and the growth prospects of the world economy have deteriorated markedly. We now predict that these developments will cause the current recession to continue in Italy this year; GDP is likely to return to modest growth only in 2010, when it will benefit from a recovery in international trade. We estimate, taking account of the Government measures to support demand, that GDP will fall by an average of 2 per cent in 2009 and return to growth of 0.5 per cent in 2010. This forecast takes into account the sharper-than-expected fall in industrial production in the last part of 2008, and in particular the figure for November released on 14 January.
Among the components of demand, industrial investment, squeezed by persistently negative or in any case highly uncertain prospects for foreign and domestic demand, is likely to be especially penalized.
Inflation is forecast to fall sharply in 2009 and remain well below 2 per cent in 2010 as well - Consumer price inflation is expected to fall to an average rate of 1.1 per cent in 2009, before edging back up to 1.4 per cent in 2010, reflecting mainly the decline in the prices of raw materials in the second half of 2008 and the forecast of their moderate recovery in the two following years. After the temporary acceleration recorded in 2008 with the conclusion of many contract renewals, employee earnings are expected to slow in 2009; unit labour costs should benefit accordingly.
The forecast is subject to conflicting uncertainties - Output performance could be even worse if the risks of a further weakening of the global economy were to materialize. A less negative scenario could be opened up by full and effective application of the plans already made and currently being defined in the major economies to stabilize financial markets and support aggregate demand.
There is broad agreement that in exceptionally adverse conditions economic policies must take every possible initiative to ease and shorten the recession, so long as the medium and long-term sustainability of the public finances is not compromised. This ultimately depends on the prospects for reactivating the process of economic growth.
