The Italian bank crisis – the one graph version

Today I was interviewed by a Danish journalist about the Italian banking crisis (read the interview here). He asked me a very good question that I think is highly relevant for understanding not only the Italian banking crisis, but the Great Recession in general.

The question was: “Lars, why is there an Italian banking crisis – after all they did NOT have a property markets bubble?”

That – my regular readers will realise – made me very happy because I could answer that the crisis had little to do with what happened before 2008 and rather was about monetary policy failure and in the case of the euro zone also why it is not an optimal currency area.

Said, in another way I repeated my view that the Italian banking crisis essentially is a consequence of too weak nominal GDP growth in Italy. As a consequence of Italy’s structural problems the country should have a significantly weaker “lira”, but given the fact that Italy is in the euro area the country instead gets far too tight monetary conditions and consequently since 2008 nominal GDP has fallen massively below the pre-crisis trend.

That is the cause of the sharp rise in non-performing loans and bad debt since 2008. The graph below clearly illustrates that.

Bad debt NGDP Italy.jpg

I think it is pretty clear that had nominal GDP growth not fallen this sharply since 2008 then we wouldn’t be talking about an Italian banking crisis today. There was no Italian “bubble” prior to 2008 and there are no signs that Italian banks have been particularly irresponsible, but even the most conservative banks will get into trouble when nominal GDP drops 25% below the pre-crisis trend.

Therefore, I also don’t think that the “solution” to the crisis is a re-capitalisation of the Italian banks or of the entire European banking sector. Rather the solution is to ensure nominal stability in the euro zone. The best way of doing that would be for the ECB to aggressive increase the money base to ensure 4% NGDP growth in the euro zone (see my recent post on what the ECB in the present situation here and my post from 2012 on a cheap firewall against an escalation of the crisis here.)

A key problem, however, is that the euro zone is not an optimal currency area. In a good recent blog post my friend Marus Nunes rightly argued that there is a “Northern” part of the euro zone where monetary policy broadly speaking is “right” and a “Southern” part, where monetary policy is far too tight. Italy is part of this later group.

This means that the question is whether keeping euro zone nominal demand “on track” is enough to ensure enough NGDP growth in the Southern countries to avoid banking and sovereign debt crisis coming back again and again. Unfortunately the development over the past eight years gives little reason for optimism.

PS There are now also increasing talk about problems in the German banking sector. Given the fact that the German economy has doing quite well compared to most other economies in Europe this is rather incredible. Therefore if we should talk about imprudent banking (due to moral hazard problems) then we might want to point the fingers at the German banks.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

Leave a comment


  1. Good one Lars!

    Wondering how Italy compares to other countries, on the same two data series.

  2. Excellent graph. Reminds me a of that classic “convergence, divergence” graph that shows EU area interest rates from 1995 to 2015 — I bet the ECB could really benefit from looking at that one mapped against the overall EU nominal GDP shortfall. Call it the “do your job, central bank!” graph.

  3. “As a consequence of Italy’s structural problems the country should have a significantly weaker “lira””

    There’s one thing I don’t understand: why don’t you advocate solving these structural problems, instead of having a weaker Lira?

    Having a weaker Lira, after all, would solve the NGDP problem, but with a lower RGDP than the other solution, fixing the structural problems. Am I wrong?

    • Maurizio, I just because I advocate ensuring nominal stability do not mean that I do not advocate structural reforms. I strongly advocate structural reform – in the case of Italy I particularly see a need for massive labour market reforms.

      That said, even very radical structural reforms will be enough to save Italy is European monetary policies remain deflationary for Italy.

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