## 1itaea2023002

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---

### Population forecasts and the demographic challenge
- Italy’s workforce is beginning to shrink due to rapid population aging, an extended period of very low fertility, and unfavorable net migration dynamics in the context of low female and youth labor participation.
- United Nations Population Division projections: working age population will decrease by nearly 30 percent over the next 25 years.
- ISTAT projections: working age population would decline by roughly 20 percent over the same period.
- Unless offset by productivity- and employment-boosting policies, aggregate output could decrease sharply, raising the per capita burden of public debt.

### Growth accounting framework and baseline assumptions
- Production function: Yt = At Kt^α Lt^{1-α}
- Capital accumulation: Kt = (1-δ) * Kt-1 + It-1
- Output growth decomposition: gY = gA + [α * gK + (1- α) * gL]
- Reference year: 2019.
- Data sources: Istat national accounts; UN World Population Prospects; Penn World Tables.
- Key parameter assumptions:
  - Investment rate: assumed to remain at its historical average of 20 percent of GDP.
  - Depreciation rate: assumed at 4 percent.

### Scenarios analyzed
- Passive scenario:
  - Unchanged TFP and constant labor force participation rates.
  - Characterized as somewhat more pessimistic than staff’s medium-term forecast.
- Greater labor force participation scenario:
  - Passive scenario augmented by a step increase in 2024 in both male and female labor force participation rates from current levels of 74 percent and 55 percent to the EU-average male participation rate of 80 percent.
- Raising effective retirement age scenario:
  - Builds on the greater participation scenario by increasing participation of older workers via prolonging working lives.
  - Italy’s statutory retirement age is 67 years, but effective retirement age is just below 64 years.
  - Scenario assumes the effective retirement age increases to 70 years in 2024.

### Scenario outcomes and key statistics
- Passive scenario: real output drops relative to 2019 by:
  - 3 percent in 2030,
  - 12 percent in 2040,
  - almost 20 percent in 2050.
- Increasing labor force participation and raising the effective retirement age raise output substantially by 2030, but are insufficient to avert output decline by 2050 without meaningful improvement in labor productivity (TFP and capital-labor ratio).

### Quick wins: policies to narrow labor market gaps
- Rationale: Near-term benefits from getting more people into work; employment and labor force participation rates are low compared with other large euro area countries, with especially low participation of women.
- Policy measures to incentivize participation:
  - Avoid social benefit traps due to high marginal rates of benefit withdrawal for low earned income.
  - Remove tax credit that discourages second earners in a household (typically women) from participating in the labor force.
  - Provide adequate affordable child- and elder-care (NRRP aims to expand childcare provision).

### Migration and labor shortages
- Trends:
  - Rising emigration outflows and fewer inflows of foreign workers are reducing Italy’s potential labor supply.
  - Italy is losing a growing number of its workforce-entry-age cohort and a growing share of its university graduates.
- Shortage estimates:
  - Government estimates indicate widespread labor shortages of about one million across different skills levels.
  - Unioncamere estimates shortages of college and high school graduates of about 20 percent and 40 percent, respectively.
  - Specific shortages: pharmacists, biologists, life scientists, physicians; at least 100,000 workers needed in agriculture.
- Policy implications:
  - Improve remuneration, working conditions, career prospects, and business opportunities for graduates.
  - Adopt a pragmatic immigration policy complemented by training and integration support.
  - International migration can boost output, create opportunities, supply skills, stimulate trade, and improve pension and fiscal balances over the longer term.

### Fertility and longevity
- Fertility rate: 1.25 (well below replacement rate of 2.1).
- Increasing longevity combined with low fertility raises the number of elderly relative to those below working age.
- Policies that could influence fertility decisions: adequate provision of affordable childcare and a tax-cum-social benefit system recognizing the high financial cost of raising children.
- With the fertility rate so low, it would take several generations of well-above-replacement-rate fertility to materially affect working-age population projections; productivity-boosting measures remain essential.

### Structural gaps and essential reforms (longer gestation)
- Productivity and structural impediments:
  - Labor productivity has lagged peers since the mid-1990s and remains stagnant relative to G7 countries.
  - Constraints: weak capacity to innovate and adopt new technologies; low level of human capital; high share of small firms.
- Employment contract dynamics:
  - Rise in precarious jobs (temporary workers and part-time employment) has reduced opportunities to accumulate on-the-job human capital.
  - About 20 percent of young people remain on fixed-term contracts after five years of employment.
  - Precarious work has widened the income distribution and reduced incomes up to at least the 25th percentile, especially affecting younger workers.
- Policy needs:
  - Comprehensive reskilling and upskilling programs to facilitate job transitions.
  - Reforms to encourage employer investment in training and to improve career progression.

### Public investment efficiency
- Public investment efficiency in Italy is well below the global public investment efficiency frontier and particularly low relative to EU countries.
- NRRP reforms aim to improve investment effectiveness; full and timely implementation is essential.
- Public investment needs will remain high; ensuring value-for-money in public investing would bring lasting benefits.
- Tools referenced: IMF's Tool for Investment and Efficiency (2021), Public Investment Management Assessment, Climate Public Investment Management Assessment.

### Business dynamism and informality
- ISTAT estimate: underground and illegal economy equivalent to 11 percent of GDP.
- Features impeding dynamism:
  - High prevalence of less productive micro and small firms and a large informal economy.
  - Trust deficit leads small firms to hire family members and avoid outside labor; informal firms remain small to conceal activity from tax authorities.
  - Birth rates of Italian enterprises are falling; family-owned businesses account for around half of GDP and nearly two-thirds of employment.
  - Succession risk: a large share of family-owned businesses have CEOs older than 70 years.
- Needed reforms: competition, public administration, civil justice, more effective capital markets including private equity.

### Youth, education, and labor market outcomes
- NEET rate: 26 percent of young people in Italy were neither in employment, education, nor training in 2021.
- Youth unemployment rate: 20 percent.
- Share of university graduates among people 25-34 years: below 30 percent in Italy, compared to the European average of over 40 percent.
- Share of young Italian teachers with tertiary degrees: 44 percent compared to the OECD average of 60 percent.
- Tertiary education yields a low wage premium in Italy, reflecting weak demand and incentivizing emigration of highly-qualified graduates.
- Policy priorities:
  - Align school curricula with in-demand skills.
  - Increase teachers’ training and professional development.
  - Effectively apply active labor market policies.
  - Provide sufficient affordable child- and elder-care.
  - Implement structural reforms to address the “trust deficit.”

### Accelerating the digital transition: digitalization and ICT skills
- Italy lags in broadband adoption, computer use, internet use, online banking, and e-commerce.
- ICT education:
  - Only 2 percent of Italian college entrants major in ICT, well-below the OECD average of 6 percent.
  - Arts and humanities are the most popular fields of study among new tertiary entrants in Italy.
- NRRP role:
  - Achieving NRRP milestones would stimulate demand for ICT skills; increase the earning premium on ICT tertiary degrees; attract more college enrollment in ICT; and reduce skill mismatches.

### Innovation and R&D
- R&D spending: 1.5 percent of GDP.
- Labor force devoted to R&D: less than 1.5 percent.
- Consequences: Italian patent applications lag other large euro area countries; economic complexity is relatively low and has declined over the last two decades.
- Need: a virtuous cycle of greater digitalization and more STEM specialists to close the innovation gap.

### Public administration and judiciary bottlenecks
- Estimated time to resolve civil and commercial legal cases is long, creating a large backlog.
- European Commission’s survey on EU justice:
  - 9 percent of Italian companies are very confident in the effectiveness of investment protection by the law and courts in their home country.
  - 40 percent of Italian firms are fairly unconfident or very unconfident.
- Recommendations:
  - Continue implementation and monitoring of the effectiveness of Italy’s new Insolvency Code.
  - Continue public administration and judicial modernizing reforms and upgrading of staffing.

### Sovereign bond spreads: empirical study context and determinants
- Dataset: country-year annual data for 2000 to 2022, 13 to 15 euro area countries.
- Model: dynamic panel regression with persistence captured by a first-order lag of spreads; estimator: Arellano-Bover/Blundell-Bond.
- Explanatory variable groups: macroeconomic fundamentals; regional and global risks; domestic policy and political uncertainty; monetary policy measures and communications.
- Key quantitative findings:
  - Macroeconomic fundamentals: countries with higher public debt tend to have wider bond spreads.
  - Real GDP growth: a one percentage point increase in growth is associated with a narrower spread of 10 basis points.
  - EU systemic stress: a unit increase is associated with a widening of spreads by 500 basis points, on average.
  - US systemic stress: a unit increase is associated with narrowing euro area spreads by about 400-500 basis points.
  - Political risk: a one standard deviation increase in the political risk index is associated with a 130 basis point widening of spreads.
  - Shadow interest rate: a percentage point increase associated with a widening of spreads by about 10-18 basis points.
  - ECB net purchases: a percentage point increase in net purchases as a share of outstanding government debt is associated with a narrowing of spreads by about 20 basis points on average, declining to about 15 basis points once purchases reach about 7 percentage points of outstanding government debt.
  - ECB communications: commitment to accommodative policy coincides with declines in spreads; the whatever-it-takes index helps narrow spreads though the average impact is not statistically significant in some specifications.

### Monetary policy: asymmetric effects on sovereign spreads
- Monetary policy’s effect on spreads is asymmetric, with larger impacts when policy is tightening.
- Signaling effects of ECB communications:
  - A one standard deviation increase in the WIT index during a tightening period is associated with a narrowing of spreads by about 30 basis points.
  - Such commitments do not have a statistically significant impact on spreads when the monetary policy stance is being loosened.
- Selected heterogeneous estimates:
  - Whatever it takes index (standardized) when tightening MP stance: -0.31* (standard error 0.16).
  - Whatever it takes index (standardized) when loosening MP stance: -0.06 (standard error 0.09).
  - ECB communication (0-1=accommodative) when tightening MP stance: -1.85*** (standard error 0.71).
  - ECB communication (0-1=accommodative) when loosening MP stance: -0.44 (standard error 0.74).
  - Shadow interest rate when positive delta (tightening): 0.17*** (standard error 0.05).
  - Shadow interest rate when negative delta (loosening): 0.19*** (standard error 0.06).

### Asset purchases, public debt, and heterogeneous country effects
- Asset purchases have larger effects on spreads of high-debt countries:
  - Interaction of asset purchases and outstanding debt ratio is negative and significant.
  - For a public debt ratio of 150 percent, a percentage point increase in net asset purchases (as a share of public debt) is associated with an almost 20 basis point decline in spreads, compared with a 12 basis point impact for a public debt ratio of 50 percent.
- Regression evidence (selected coefficients):
  - PSPP+PEPP net purchase (percent of public debt): -0.11*** (standard error 0.02).
  - PSPP+PEPP net purchase x high debt country: -0.25*** (standard error 0.05).
  - PSPP+PEPP net purchase x non-high debt country: -0.08*** (standard error 0.02).
  - PSPP+PEPP net purchase x public debt ratio: -0.0005*** (standard error 0.00).
- Note: Public debt ratio can proxy for borrower credit risk and the size/depth of sovereign bond market.

### Implications for Italy’s spreads and policy interaction
- Key factors influencing Italy’s sovereign bond spreads in recent years: public debt, unconventional monetary policy, and political risk.
- Over the past five years, these factors explained nearly two-thirds of movements in Italy’s spreads.
- Implications:
  - Quantitative tightening could weigh on Italy’s spreads more than for other euro area countries due to Italy’s share of government bonds held by the ECB relative to total public debt and high public debt magnifying the impact of unwinding sovereign bond holdings.
  - Persistently lowering the public debt ratio could moderate spread widening directly and indirectly (via interaction with euro area monetary conditions).
  - Faster growth and reinforcing political stability could help contain spreads.
  - The ECB’s commitment to support effective transmission of monetary policy could help limit asynchronous country-specific interest-rate reactions.

### Reaching climate targets: firm- and sector-level implications for Italy
- Italy committed to reducing carbon emissions by 55 percent by 2030 relative to 1990 levels under the EU’s Fit-for-55 initiative.
- To meet this target, emissions would need to decline by a further 33 percent relative to a forecast based on the trend of the last 5 years.
- Sectoral laggers: agriculture, transport, and “other sectors” (mainly services).
- Firm-level scenario (sample of 1,192 firms):
  - If firms with weaker environmental performance improve to the 25th percentile of emission intensities for their industry:
    - Sample total emissions fall by 43 percent in manufacturing.
    - Sample total emissions fall by nearly 67 percent in other sectors (excluding finance, energy, and utilities).
- Policy simulation on carbon pricing and allowances:
  - A uniform carbon tax of €40 per ton could reduce within-industry variation in carbon emissions by more than 40 percent, helping to reduce total emissions by 25 percent.
  - Phasing out free allowances and applying a uniform carbon price in industry would help lift performance of firms with higher emissions intensity, but costs would fall disproportionately on older firms with less-green capital.

*Source: 1itaea2023002*

### 1. Population Forecasts _____________________________________________________________ 3

### 1. Population Forecasts

### The Demographic Challenge
- Italy’s workforce is beginning to shrink due to rapid population aging, an extended period of very low fertility, and unfavorable net migration dynamics in the context of low female and youth labor participation.
- United Nations Population Division projections indicate that Italy’s working age population will decrease by nearly 30 percent over the next 25 years.
- The latest ISTAT projections are less negative and show that the Italian working age population would decline by roughly 20 percent over the same period.
- Unless offset by productivity- and employment-boosting policies, aggregate output could decrease sharply, raising the per capita burden of public debt.

### Growth Accounting Framework and Assumptions
- Aggregate output modeled with a standard Cobb-Douglas production function:
  - Yt = At Kt^α Lt^{1-α}
  - Kt = (1-δ) * Kt-1 + It-1
  - Output growth: gY = gA + [α * gK + (1- α) * gL]
- Reference year: 2019.
- Data sources: Istat national accounts for output and investment; UN World Population Prospects for population projections; Penn World Tables for capital-output ratio and depreciation.
- Key parameter assumptions:
  - Investment rate assumed to remain at its historical average of 20 percent of GDP.
  - Depreciation rate assumed at 4 percent.

### Scenarios Analyzed
- Passive scenario:
  - Unchanged TFP and constant labor force participation rates.
  - Characterized as somewhat more pessimistic than staff’s medium-term forecast.
- Greater labor force participation scenario:
  - Passive scenario augmented by a step increase in 2024 in both male and female labor force participation rates from current levels of 74 percent and 55 percent to the EU-average male participation rate of 80 percent.
- Raising effective retirement age scenario:
  - Builds on the greater participation scenario by increasing participation of older workers via prolonging working lives.
  - Italy’s statutory retirement age is 67 years, but effective retirement age is just below 64 years.
  - Scenario assumes the effective retirement age increases to 70 years in 2024.

### Scenario Outcomes and Key Statistics
- In the passive scenario, real output drops relative to 2019 by:
  - 3 percent in 2030,
  - 12 percent in 2040,
  - almost 20 percent in 2050.
- Increasing labor force participation and raising the effective retirement age raise output substantially by 2030 (when demographic drag is still small), but are insufficient to avert output decline by 2050 without meaningful improvement in labor productivity (TFP and capital-labor ratio).

### Quick Wins: Policies to Narrow Labor Market Gaps
- Near-term benefits from getting more people into work; employment and labor force participation rates are low compared with other large euro area countries, with especially low participation of women.
- Policy measures to incentivize participation:
  - Avoid social benefit traps due to high marginal rates of benefit withdrawal for low earned income.
  - Remove tax credit that discourages second earners in a household (typically women) from participating in the labor force.
  - Provide adequate affordable child- and elder-care (NRRP aims to expand childcare provision).

### Migration and Labor Shortages
- Rising emigration outflows and fewer inflows of foreign workers are reducing Italy’s potential labor supply.
- Italy is losing a growing number of its workforce-entry-age cohort and a growing share of its university graduates.
- Government estimates indicate widespread labor shortages of about one million across different skills levels.
- Unioncamere estimates shortages of college and high school graduates of about 20 percent and 40 percent, respectively.
- Specific shortages:
  - Increasingly difficult to find pharmacists, biologists, life scientists, and physicians.
  - At least 100,000 workers needed to fill the labor shortage in agriculture.
- Policy implications:
  - Improve remuneration, working conditions, career prospects, and business opportunities for graduates.
  - Adopt a pragmatic immigration policy complemented by training and integration support.
  - International migration can boost output, create opportunities, supply skills, stimulate trade, and improve pension and fiscal balances over the longer term.

### Fertility and Longevity
- Italy’s fertility rate is 1.25, well below the replacement rate of 2.1.
- Increasing longevity combined with low fertility raises the number of elderly relative to those below working age.
- Policies that could influence fertility decisions include adequate provision of affordable childcare and a tax-cum-social benefit system recognizing the high financial cost of raising children.
- With the fertility rate so low, it would take several generations of well-above-replacement-rate fertility to materially affect working-age population projections; thus productivity-boosting measures remain essential.

### Structural Gaps and Essential Reforms (Longer Gestation)
- Labor productivity has lagged peers since the mid-1990s and remains stagnant relative to G7 countries.
- Factors holding back productivity include:
  - Weak capacity to innovate and adopt new technologies.
  - Low level of human capital.
  - High share of small firms in the economy.
- Employment contract dynamics:
  - Rise in precarious jobs (temporary workers and part-time employment) has reduced opportunities to accumulate on-the-job human capital.
  - About 20 percent of young people remain on fixed-term contracts after five years of employment.
  - Precarious work has widened the income distribution and reduced incomes up to at least the 25th percentile, especially affecting younger workers.
- Policy needs:
  - Comprehensive reskilling and upskilling programs to facilitate job transitions.
  - Reforms to encourage employer investment in training and to improve career progression.

### Public Investment Efficiency
- Public investment efficiency in Italy is well below the global public investment efficiency frontier and particularly low relative to EU countries.
- NRRP reforms aim to improve investment effectiveness; full and timely implementation is essential.
- Public investment needs will remain high; ensuring value-for-money in public investing would bring lasting benefits.
- Tools referenced: IMF's Tool for Investment and Efficiency (2021), Public Investment Management Assessment, Climate Public Investment Management Assessment.

### Business Dynamism and Informality
- High prevalence of less productive micro and small firms and a large informal economy hold back productivity and labor participation.
- ISTAT estimates the underground and illegal economy in Italy is equivalent to 11 percent of GDP.
- Trust deficit leads small firms to hire family members and avoid outside labor; informal firms remain small to conceal activity from tax authorities, reducing incentives to modernize production.
- Birth rates of Italian enterprises are falling; family-owned businesses account for around half of GDP and nearly two-thirds of employment.
- Succession risk: a large share of family-owned businesses have CEOs older than 70 years.
- Needed reforms: competition, public administration, civil justice, more effective capital markets including private equity.

### Youth, Education, and Labor Market Outcomes
- NEET rate: 26 percent of young people in Italy were neither in employment, education, nor training in 2021.
- Youth unemployment rate: 20 percent.
- Share of university graduates among people 25-34 years is below 30 percent in Italy, compared to the European average of over 40 percent.
- Lower-than-average share of young Italian teachers with tertiary degrees: 44 percent compared to the OECD average of 60 percent.
- Tertiary education yields a low wage premium in Italy, reflecting weak demand and incentivizing emigration of highly-qualified graduates.
- Policy priorities:
  - Align school curricula with in-demand skills.
  - Increase teachers’ training and professional development.
  - Effectively apply active labor market policies.
  - Provide sufficient affordable child- and elder-care.
  - Implement structural reforms to address the “trust deficit.”

*Prepared by IMF staff; chapter prepared by Sylwia Nowak and Zhongxia (Sam) Zhang.*

### 13.      Accelerating the digital transition is

### 13.      Accelerating the digital transition is

### Digitalization and ICT skills: findings and implications
- Italy currently lags in digitalization across broadband technology adoption, computer use, internet use, online banking, and e-commerce.
- Only 2 percent of Italian college entrants major in ICT, well-below the OECD average of 6 percent.
- Arts and humanities are the most popular fields of study among new entrants into tertiary education in Italy.
- To close the digital gap and ensure sufficient supply of ICT workers, Italy needs to achieve the NRRP’s detailed milestones and targets on digitalization.
- Achieving NRRP milestones would:
  - stimulate demand for ICT skills;
  - increase the earning premium on ICT tertiary degrees;
  - attract more college enrollment in ICT; and
  - reduce skill mismatches in the labor market.

### Innovation and R&D: current status and needs
- Italy’s spending on R&D is 1.5 percent of GDP.
- Less than 1.5 percent of the labor force is devoted to R&D.
- As a result, Italian patent applications lag other large euro area countries.
- Italy's economic complexity is relatively low among advanced countries and its ranking has declined over the last two decades.
- A virtuous cycle of greater digitalization and more STEM specialists is needed to close the innovation gap and improve comparative advantage in products and services closer to the technology frontier.

### Public administration and judiciary: bottlenecks
- Estimated time to resolve civil and commercial legal cases is long in Italy, resulting in a large backlog of pending cases.
- According to the European Commission’s survey on EU justice:
  - Only 9 percent of Italian companies are very confident in the effectiveness of investment protection by the law and courts in their home country.
  - 40 percent of Italian firms are fairly unconfident or very unconfident.
- Recommendations:
  - Continue implementation and monitoring of the effectiveness of Italy’s new Insolvency Code.
  - Continue public administration and judicial modernizing reforms and upgrading of staffing.

### Conclusions: growth, productivity, and reform urgency
- Italy faces a demographic drag on output but has large catch-up potential.
- On numerous metrics Italy is among the worst EU performers in areas affecting output, including female labor force participation, NEET youth, educational attainment, and digitalization.
- Increasing employment is essential but not sufficient; without higher capital and total factor productivity, higher employment would not achieve positive long-run growth.
- Italy needs a sustained, pro-growth strategy to significantly boost productivity to counteract demographic decline.
- Reforms are needed on education, competition, public administration, and the judicial system; such transformational change likely entails long gestation periods and thus should be implemented promptly and decisively.

### Empirical study context (sovereign bond spreads)
- Dataset: country-year annual data for the period 2000 to 2022, encompassing 13 to 15 euro area countries.
- Model: dynamic panel regression with persistence captured by a first-order lag of spreads; estimator: Arellano-Bover/Blundell-Bond.
- Explanatory variable groups:
  - Macroeconomic fundamentals: public debt to GDP ratio, primary fiscal balance (as a share of GDP), real GDP growth, inflation, current account balance (as a share of GDP).
  - Common regional and global risks: composite indicators of systematic stress for the euro area and the US, and implied volatilities of US and European stock markets.
  - Domestic policy and political uncertainty: economic policy uncertainty indices, country-level world uncertainty index, ICRG’s composite rating index of political risks.
  - Monetary policy: ECB policy interest rate, shadow interest rate and gap to neutral, net purchases under APP and PEPP (as a share of a country’s public debt), and text-based indices measuring ECB communications (including a whatever-it-takes index).

### Determinants of euro area sovereign bond spreads: key quantitative findings
- Macroeconomic fundamentals:
  - Countries with higher public debt tend to have wider bond spreads.
  - A one percentage point increase in growth is associated with a narrower spread of 10 basis points.
- Regional and political risks:
  - A unit increase in the EU systemic stress index is associated with a widening of countries’ spreads by 500 basis points, on average.
  - A unit increase in the US systemic stress index is associated with narrowing euro area countries’ spreads by about 400-500 basis points (consistent with flight-to-safety).
  - A one standard deviation increase in the political risk index is associated with a 130 basis point widening of spreads.
- Monetary policy effects:
  - ECB policy interest rate: positive association with spreads; not statistically significant when ignoring ZLB, but becomes stronger when the ZLB environment is considered.
  - Shadow interest rate: a percentage point increase in the shadow interest rate is associated with a widening of spreads by about 10-18 basis points.
  - ECB net purchases of country-specific government securities:
    - A percentage point increase in net purchases as a share of that country’s outstanding government debt is associated with a narrowing of spreads by about 20 basis points on average.
    - The average effect is subject to diminishing returns—declining to about 15 basis points once the amount purchased has risen to about 7 percentage points of outstanding government debt.
  - ECB communications:
    - Communications regarding commitment to accommodative policy coincide with declines in euro area government bond spreads.
    - The whatever-it-takes index appears to help narrow spreads, but the estimated average impact is not statistically significant.

*Source: 1itaea2023002*

### 9.      In addition, monetary policy’s effect on spreads is found to be asymmetric, with larger

### 1itaea2023002 - 9.      In addition, monetary policy’s effect on spreads is found to be asymmetric, with larger

### Monetary policy: asymmetric effects on sovereign spreads
- Monetary policy’s effect on spreads is asymmetric, with larger impacts when policy is tightening.
- Signaling effects of ECB communications show sizable asymmetry:
  - A one standard deviation increase in the WIT index during a tightening period is associated with a narrowing of spreads by about 30 basis points.
  - Such commitments do not have a statistically significant impact on spreads when the monetary policy stance is being loosened.
- Heterogeneous effects reported in regressions (Table 2) include:
  - Whatever it takes index (standardized) when tightening MP stance: -0.31* (standard error 0.16).
  - Whatever it takes index (standardized) when loosening MP stance: -0.06 (standard error 0.09).
  - ECB communication (0-1=accommodative) when tightening MP stance: -1.85*** (standard error 0.71).
  - ECB communication (0-1=accommodative) when loosening MP stance: -0.44 (standard error 0.74).
- Monetary policy stance and shadow rates:
  - Shadow interest rate when positive delta (tightening): 0.17*** (standard error 0.05).
  - Shadow interest rate when negative delta (loosening): 0.19*** (standard error 0.06).

### Asset purchases, public debt, and heterogeneous country effects
- Asset purchases have materially larger effects on spreads of high-debt euro area countries:
  - Interaction term of asset purchases and the outstanding debt ratio is negative and significant.
  - A percentage point increase (decrease) in net asset purchases (as a share of public debt) is associated with an almost 20 basis point decline (increase) in bond spreads for countries with a public debt ratio of 150 percent, compared with a 12 basis point impact for those with a public debt ratio of 50 percent.
- Regression evidence (Table 2) on asset purchases:
  - PSPP+PEPP net purchase (percent of public debt): -0.11*** (standard error 0.02).
  - PSPP+PEPP net purchase (percent of public debt) x high debt country: -0.25*** (standard error 0.05).
  - PSPP+PEPP net purchase (percent of public debt) x non-high debt country: -0.08*** (standard error 0.02).
  - PSPP+PEPP net purchase (percent of public debt) x the public debt ratio: -0.0005*** (standard error 0.00).
- Note: Public debt ratio can proxy for borrower credit risk and the size/depth of sovereign bond market.

### Implications for Italy
- Key factors influencing Italy’s sovereign bond spreads in recent years: public debt, unconventional monetary policy, and political risk.
- Over the past five years, these factors explained nearly two-thirds of movements in Italy’s spreads.
- Interaction and projection implications:
  - Quantitative tightening could be expected to weigh on Italy’s spreads more than for other euro area countries because of Italy’s share of government bonds held by the ECB relative to total public debt and because a high public debt level magnifies the impact of unwinding sovereign bond holdings.
  - Persistently lowering the public debt ratio could moderate spread widening both directly (debt’s effect on spreads) and indirectly (debt’s interaction with euro area monetary conditions).
  - Faster growth and reinforcing political stability could help contain spreads.
  - The ECB’s commitment to support effective transmission of monetary policy could help limit asynchronous country-specific interest-rate reactions.
- Empirical decomposition (Italy chart): model components shown include W.I.T, Asset net purchase, Shadow i-rate, Political risks, EU & US risks, Growth & inflation, Public debt, and lagged spread contributing to actual vs projected Italy 10-Year sovereign spread.

### Empirical results: selected coefficients and diagnostics (Euro area panel)
- Lagged spread on 10Y government bond (ppt; vis-a-vis DEU): coefficients range from 0.19 to 0.39 with many estimates statistically significant at *** or ** levels.
- Public debt (percent of GDP): 0.01*** across specifications (standard errors shown as 0.00).
- Real GDP growth (percent): coefficients around -0.08 to -0.11*** (standard errors 0.02 or 0.03).
- Inflation (percent): coefficients positive, e.g., 0.21*** (standard error 0.05) in some specifications; other specs show 0.10** (standard error 0.05).
- EU Systematic stress index: large positive coefficients, e.g., 7.11*** (standard error 0.86).
- US Systematic stress index: large negative coefficients, e.g., -6.67*** (standard error 1.10).
- Political risk rating (high=high risk): positive and significant, e.g., 1.39*** (standard error 0.20).
- PSPP+PEPP net purchase (percent of public debt): -0.22*** (standard error 0.06) in Table 1 specifications; quadratic term PSPP+PEPP net purchase (percent of public debt; square): 0.01* (standard error 0.01).
- Estimation: Dynamic panel data (Arellano-Bover/Blundell-Bond) estimator; including time trend and country fixed effects. Observations generally 244; country sample size 13.

### Reaching climate targets: firm-level and sectoral implications for Italy
- Italy’s commitments and gap:
  - Italy committed to reducing carbon emissions by 55 percent by 2030 relative to 1990 levels under the EU’s Fit-for-55 initiative.
  - To meet this target, emissions would need to decline by a further 33 percent relative to a forecast based on the trend of the last 5 years.
  - The required reduction differs considerably across sectors; agriculture, transport, and “other sectors” (mainly services) are lagging.
- Firm-level potential gains:
  - Sample: 1,192 firms.
  - Scenario: firms with weaker environmental performance improve to the 25th percentile of emission intensities for their industry.
  - Resulting reductions in sample total emissions: by 43 percent in manufacturing, and nearly 67 percent in other sectors (excluding finance, energy, and utilities).
- Policy simulation on carbon pricing and allowances:
  - A uniform carbon tax of €40 per ton could reduce within-industry variation in carbon emissions by more than 40 percent, helping to reduce total emissions by 25 percent.
  - Phasing out free allowances and applying a uniform carbon price in industry would help lift performance of firms with higher emissions intensity, but costs would fall disproportionately on older firms with less-green capital.

*Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1itaea2023002.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1itaea2023002.pdf_