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### I. BACKGROUND
- Italy faces modest growth, high public debt, and a banking system burdened with high nonperforming loans and weak profitability.
- Recovery is weighed down by long-standing structural problems, imbalances, and strained balance sheets; slow recovery hinders balance sheet restoration.
- On current projections, growth remains too modest to decisively reverse imbalances and lower debt.
- Competitiveness assessment:
  - Current account surplus since 2013 driven mostly by import compression from a decline in investment and large commodity terms of trade gains.
  - Export recovery has lagged.
  - Desirable policy settings and medium-term fundamentals (including rapid aging) imply a higher equilibrium current account balance.
  - Unit labor costs rose notably after euro accession; wage gains have outstripped productivity.
  - Real exchange rate estimated to be overvalued on the order of 10 percent.
- Recommended comprehensive policy response components:
  - Fiscal consolidation with growth-friendly, inclusive measures.
  - Wage bargaining reforms to align wages with productivity at the firm level.
  - Other structural reforms: product market, labor market, public administration.
  - Financial sector measures to speed cleanup of bank balance sheets and corporate restructuring.

### II. REFORM PROGRAM (GIMF simulation framework and mapping)
- Modeling approach:
  - Uses the IMF’s Global Integrated Monetary and Fiscal Model (GIMF).
  - Structural policies phased in over a 5–10-year horizon, step-wise, fully implemented and credible at the fifth year.
  - Structural reforms are mapped to changes in GIMF structural parameters (wage and price markups, labor supply, total factor productivity or TFP, etc.).
- Policy package modeled (aggregate fiscal scale and measures):
  - Total fiscal consolidation of 2 percent of GDP over four years.
  - Reduce labor tax wedge by 1½ percent of GDP via revenue-neutral, less distortionary tax reform.
  - Finance by lowering VAT gaps (compliance and policy) by 1 percent of GDP.
  - Property tax on primary residences: ½ percent of GDP.
  - Current primary spending cuts: reduce large social benefits and spending on goods and services, both by 1¼ percent of GDP.
  - Increase public capital spending by ½ percent of GDP.
- Wage bargaining reform:
  - Move from sectoral-level to firm-level wage setting.
  - Simulated as a reduction in the wage markup by about 15 p.p.
  - Consistent with Kangur (2017) estimate: steady-state employment increase of about 4 percent.
- Other structural reforms:
  - Labor market reforms (fiscally-neutral reallocation):
    - Scale up active labor market policies (ALMPs): 0.4 percent of GDP.
    - Increase spending on childcare: 0.2 percent of GDP.
    - Broaden social safety net to cover all those below poverty line: 0.5 percent of GDP.
    - Modeled as neutral spending reallocation phased over five years; labor supply effects derived from OECD estimates.
  - Product market reforms:
    - Ease regulatory barriers in retail trade, professionals, select network sectors.
    - Assumed closure of distance-to-frontier by one-half, equivalent to improvement in non-tradable PMR score by about 17 percent, phased in over 5–10 years.
    - Mapping into a non-tradable TFP shock follows OECD estimates.
  - Public administration reforms:
    - Increase public sector efficiency toward frontier in health, education, civil justice, child care, waste collection.
    - Assumed about one-half of distance to frontier closed via an economy-wide TFP shock; Giordano and others (2015) estimate full closing would expand output for an average firm by 3 percent.
- Banking sector clean-up:
  - High NPLs reduce bank profitability and lending, drag on economic activity.
  - Empirical estimates: mean reverting NPL ratio to normal levels (around 5–6 percent) would lead to a 3 percent higher real GDP in the long run.
  - ARDL/DL estimates: all estimates of effect on long-run real GDP growth are about –0.08 and statistically significant at the 1% level; a 5 percent persistent increase in the NPL ratio per year is associated with 0.4 percentage points lower annual GDP growth in the long run, on average.
  - Modeled by reducing NPL ratio to normal levels in five years and sustaining them, implying higher real GDP by about 2 percent in five years and around 3 percent in steady state.
  - Mapped into GIMF via a TFP shock distributed ¾ into the non-tradable sector and ¼ into the tradable sector (interpreted as recovering value from existing NPL stock through accelerated insolvency/workout procedures rather than higher upfront provisioning or capital costs).

### III. RESULTS AND POLICY DISCUSSION
- Aggregate impact of the reform package:
  - Potential increase in output by 6–13 percent above the baseline and a notable REER depreciation over the medium term.
  - About one-half of competitiveness gains stem from structural reforms, particularly wage bargaining; the other half from growth-enhancing fiscal devaluation, spending rebalancing, and bank balance-sheet cleanup.
- Short- and medium-term dynamics:
  - Medium-term output gains are substantial; short-term output losses are very limited.
  - Fiscal consolidation alone: peak real GDP about ½ percent below baseline after three years.
  - Combined with upfront structural reforms and bank balance-sheet cleanup, fiscal consolidation costs are offset.
- Uncertainty and prudence:
  - Realized yields may be smaller due to model uncertainty, measurement error, interim shocks, implementation challenges.
  - It may be prudent to regard the estimated medium-term growth increases as upper-bound possibilities.
- Complementary policies to enhance gains:
  - Judicial reforms: improve inefficient judicial system to reduce administrative inefficiencies, lower cost of credit, speed NPL workouts, and support firm size and labor market efficiency.
  - Employment protection: accelerate and further ease employment protection legislation (including possibly in public sector) to facilitate labor allocation and adjustment; this would reinforce wage-bargaining gains and restructuring.
  - Innovation and R&D:
    - Private R&D business spending is almost 1 percent of GDP below OECD average.
    - GIMF simulations (based on OECD mapping): increasing R&D spending by about 1 percent of GDP, phased in over five years, could in ten years increase real output by 1¼ percent and improve competitiveness by 0.3 percent; long-run gains could reach 1.9 percent (output) and 0.6 percent (competitiveness).

### IV. CONCLUSION
- Italy’s growth and exports have recently picked up but lag European peers; real exchange rate assessed moderately overvalued.
- Further fiscal, financial, wage bargaining, and complementary structural reforms would raise growth rates and unwind remaining imbalances.
- Quantified reform package indicates sizeable medium-term gains in output and competitiveness and very limited short-term losses if implemented comprehensively and decisively.

### Box 1. The Global Integrated Monetary and Fiscal Model (GIMF)
- Model overview:
  - GIMF is a multi-country structural dynamic general equilibrium model featuring Italy, the rest of the euro area, and the rest of the world.
  - Links behavior of households, firms, and government sectors within and among countries.
  - Has a consistent system of national accounting and stock-flow budget constraints for all sectors, including the government.
  - Belongs to exogenous-growth types of models: the long-term growth of output is exogenous. Fiscal or structural measures can change the structure of the economy and permanently increase the level of real output per capita, but cannot change long-term growth.
- Household sector:
  - Two types of households:
    - Forward-looking optimizing households modeled as overlapping generations (OLG) with finite lives, following the Blanchard-Weil-Yaari framework. The presence of OLG households breaks Ricardian equivalence.
    - Liquidity-constrained households who spend all their available income every period.
  - Households gain utility from consumption and disutility from labor effort; consume traded and non-traded services and goods; receive labor income, transfers from the government, dividends from corporations; pay taxes—income, consumption, and lump-sum taxes.
- Firms and monetary policy:
  - Firms produce intermediate and final goods using labor and capital inputs, accumulate capital, and import or export production; pay taxes from corporate income.
  - Monetary policy: In the euro area and rest of world regions, follows an inflation-forecast targeting rule to set policy interest rates. Italy is modeled as a member of the euro area.
- Government behavior and fiscal sustainability:
  - Government collects tax revenues (consumption, labor income, capital income, and lump-sum taxes).
  - Government spending includes government consumption, investment, and transfers to households.
  - Governments target specific debt-to-GDP (and thus deficit-to-GDP) ratios and use a mix of instruments to achieve targets.
  - The government’s commitment to sustainable public finance is credible for firms and households, who hold the stock of government bonds.
- Figures and table outputs summarized:
  - Simulation outputs include Real GDP, Consumption, Investment, Current Account/GDP, Real Effective Exchange Rate, Primary Surplus/GDP, Debt/GDP, Interest Expenditure/GDP (all reported as deviations from baseline or percent deviations where specified).
  - Table mapping of GIMF simulation strategy lists measures, GIMF instruments/shocks, and exact scales used (see measures and scales in reform program section above).

*Source: IMF staff estimates.*

### REFERENCES ______________________________________________________________15

### REFERENCES ______________________________________________________________15

### I. BACKGROUND
- Italy faces modest growth, high public debt, and a banking system burdened with high nonperforming loans and weak profitability.
- Recovery is weighed down by long-standing structural problems, imbalances, and strained balance sheets; slow recovery hinders balance sheet restoration.
- On current projections, growth remains too modest to decisively reverse imbalances and lower debt.
- Competitiveness assessment:
  - Current account surplus since 2013 driven mostly by import compression from a decline in investment and large commodity terms of trade gains.
  - Export recovery has lagged.
  - Desirable policy settings and medium-term fundamentals (including rapid aging) imply a higher equilibrium current account balance.
  - Unit labor costs rose notably after euro accession; wage gains have outstripped productivity.
  - Real exchange rate estimated to be overvalued on the order of 10 percent.
- Recommended comprehensive policy response components:
  - Fiscal consolidation with growth-friendly, inclusive measures.
  - Wage bargaining reforms to align wages with productivity at the firm level.
  - Other structural reforms: product market, labor market, public administration.
  - Financial sector measures to speed cleanup of bank balance sheets and corporate restructuring.

### II. REFORM PROGRAM (GIMF simulation framework and mapping)
- Modeling approach:
  - Uses the IMF’s Global Integrated Monetary and Fiscal Model (GIMF).
  - Structural policies phased in over a 5–10-year horizon, step-wise, fully implemented and credible at the fifth year.
  - Structural reforms are mapped to changes in GIMF structural parameters (wage and price markups, labor supply, total factor productivity or TFP, etc.).
- Policy package modeled:
  - Fiscal adjustment and rebalancing (total fiscal consolidation of 2 percent of GDP over four years), consisting of:
    - Reduce labor tax wedge by 1½ percent of GDP via revenue-neutral, less distortionary tax reform.
    - Finance by lowering VAT gaps (compliance and policy) by 1 percent of GDP.
    - Property tax on primary residences: ½ percent of GDP.
    - Current primary spending cuts: reduce large social benefits and spending on goods and services, both by 1¼ percent of GDP.
    - Increase public capital spending by ½ percent of GDP.
  - Wage bargaining reform:
    - Move from sectoral-level to firm-level wage setting.
    - Simulated as a reduction in the wage markup by about 15 p.p.
    - Consistent with Kangur (2017) estimate: steady-state employment increase of about 4 percent.
  - Other structural reforms:
    - Labor market reforms (fiscally-neutral reallocation):
      - Scale up active labor market policies (ALMPs): 0.4 percent of GDP.
      - Increase spending on childcare: 0.2 percent of GDP.
      - Broaden social safety net to cover all those below poverty line: 0.5 percent of GDP.
      - Modeled as neutral spending reallocation phased over five years; labor supply effects derived from OECD estimates.
    - Product market reforms:
      - Ease regulatory barriers in retail trade, professionals, select network sectors.
      - Assumed closure of distance-to-frontier by one-half, equivalent to improvement in non-tradable PMR score by about 17 percent, phased in over 5–10 years.
      - Mapping into a non-tradable TFP shock follows OECD estimates.
    - Public administration reforms:
      - Increase public sector efficiency toward frontier in health, education, civil justice, child care, waste collection.
      - Assumed about one-half of distance to frontier closed via an economy-wide TFP shock; Giordano and others (2015) estimate full closing would expand output for an average firm by 3 percent.
  - Banking sector clean-up:
    - High NPLs reduce bank profitability and lending, drag on economic activity.
    - Empirical estimates: mean reverting NPL ratio to normal levels (around 5–6 percent) would lead to a 3 percent higher real GDP in the long run.
    - ARDL/DL estimates: all estimates of effect on long-run real GDP growth are about –0.08 and statistically significant at the 1% level; a 5 percent persistent increase in the NPL ratio per year is associated with 0.4 percentage points lower annual GDP growth in the long run, on average.
    - Modeled by reducing NPL ratio to normal levels in five years and sustaining them, implying higher real GDP by about 2 percent in five years and around 3 percent in steady state.
    - Mapped into GIMF via a TFP shock distributed ¾ into the non-tradable sector and ¼ into the tradable sector (interpreted as recovering value from existing NPL stock through accelerated insolvency/workout procedures rather than higher upfront provisioning or capital costs).

### III. RESULTS AND POLICY DISCUSSION
- Aggregate impact of the reform package:
  - Potential increase in output by 6–13 percent above the baseline and a notable REER depreciation over the medium term.
  - About one-half of competitiveness gains stem from structural reforms, particularly wage bargaining; the other half from growth-enhancing fiscal devaluation, spending rebalancing, and bank balance-sheet cleanup.
- Short- and medium-term dynamics:
  - Medium-term output gains are substantial; short-term output losses are very limited.
  - Fiscal consolidation alone: peak real GDP about ½ percent below baseline after three years.
  - Combined with upfront structural reforms and bank balance-sheet cleanup, fiscal consolidation costs are offset.
- Uncertainty and prudence:
  - Realized yields may be smaller due to model uncertainty, measurement error, interim shocks, implementation challenges.
  - It may be prudent to regard the estimated medium-term growth increases as upper-bound possibilities.
- Complementary policies to enhance gains:
  - Judicial reforms: improve inefficient judicial system to reduce administrative inefficiencies, lower cost of credit, speed NPL workouts, and support firm size and labor market efficiency.
  - Employment protection: accelerate and further ease employment protection legislation (including possibly in public sector) to facilitate labor allocation and adjustment; this would reinforce wage-bargaining gains and restructuring.
  - Innovation and R&D:
    - Private R&D business spending is almost 1 percent of GDP below OECD average.
    - GIMF simulations (based on OECD mapping): increasing R&D spending by about 1 percent of GDP, phased in over five years, could in ten years increase real output by 1¼ percent and improve competitiveness by 0.3 percent; long-run gains could reach 1.9 percent (output) and 0.6 percent (competitiveness).

### IV. CONCLUSION
- Italy’s growth and exports have recently picked up but lag European peers; real exchange rate assessed moderately overvalued.
- Further fiscal, financial, wage bargaining, and complementary structural reforms would raise growth rates and unwind remaining imbalances.
- Quantified reform package indicates sizeable medium-term gains in output and competitiveness and very limited short-term losses if implemented comprehensively and decisively.

*Source: IMF staff estimates.*

### Box 1. The Global Integrated Monetary and Fiscal Model (GIMF)

### Box 1. The Global Integrated Monetary and Fiscal Model (GIMF)

### Model overview
- GIMF is a multi-country structural dynamic general equilibrium model featuring Italy, the rest of the euro area, and the rest of the world.
- Links behavior of households, firms, and government sectors within and among countries.
- Has a consistent system of national accounting and stock-flow budget constraints for all sectors, including the government.
- Belongs to exogenous-growth types of models: the long-term growth of output is exogenous. Fiscal or structural measures can change the structure of the economy and permanently increase the level of real output per capita, but cannot change long-term growth.

### Household sector
- Two types of households:
  - Forward-looking optimizing households modeled as overlapping generations (OLG) with finite lives, following the Blanchard-Weil-Yaari framework.
    - The presence of OLG households breaks Ricardian equivalence.
  - Liquidity-constrained households who spend all their available income every period.
- Households:
  - Gain utility from consumption and disutility from labor effort.
  - Consume traded and non-traded services and goods.
  - Receive labor income, transfers from the government, dividends from corporations.
  - Pay taxes—income, consumption, and lump-sum taxes.

### Firms and monetary policy
- Firms:
  - Produce intermediate and final goods using labor and capital inputs.
  - Accumulate capital, and import or export production.
  - Pay taxes from corporate income.
- Monetary policy:
  - In the euro area and rest of world regions, follows an inflation-forecast targeting rule to set policy interest rates.
  - Italy is modeled as a member of the euro area.

### Government behavior and fiscal sustainability
- Government collects tax revenues (consumption, labor income, capital income, and lump-sum taxes).
- Government spending includes government consumption, investment, and transfers to households.
- Governments target specific debt-to-GDP (and thus deficit-to-GDP) ratios and use a mix of instruments to achieve targets.
- The government’s commitment to sustainable public finance is credible for firms and households, who hold the stock of government bonds.

### Figures: Italy simulation outputs (summary of indicators displayed)
- Figures 1–5 show dynamic simulation responses (horizontal axis = years, SS = steady state) with impacts expressed as:
  - Real GDP (Percent deviation from baseline)
  - Consumption (Percent deviation from baseline)
  - Investment (Percent deviation from baseline)
  - Current Account/GDP (Difference from baseline)
  - Real Effective Exchange Rate (Percent deviation from baseline; "+" = appreciation)
  - Primary Surplus/GDP (Difference from baseline)
  - Debt/GDP (Difference from baseline)
  - Interest Expenditure/GDP (Difference from baseline)
- Specific figure focus:
  - Figure 1. Italy: Fiscal Reform (red = revenue rebalancing; blue = total impact)
  - Figure 2. Italy: Wage Bargaining (blue = total impact)
  - Figure 3. Italy: Other Structural Reforms: Product Markets, Public Sector Efficiency, Guaranteed Minimum Income, ALMPs, and Child Care (blue = total impact)
  - Figure 4. Italy: NPL Reduction (blue = total impact)
  - Figure 5. Italy: Total Reform Package (blue = total impact)

### Table 1. Italy: GIMF Simulation Strategy — Measures, instruments/shocks, scale, and mapping
- Fiscal Adjustment and Rebalancing
  - Lower untargeted social transfers
    - GIMF instrument / shock: General untargeted transfers
    - Scale: 1¼ percent of GDP
  - Lower spending on goods and services
    - GIMF instrument / shock: Government consumption
    - Scale: 1¼ percent of GDP
  - Higher spending on public investment
    - GIMF instrument / shock: Government investment
    - Scale: ½ percent of GDP
  - Lower tax wedge on labor
    - GIMF instrument / shock: Taxes on labor
    - Scale: 1½ percent of GDP
  - Higher VAT revenue
    - GIMF instrument / shock: Taxes on consumption
    - Scale: 1 percent of GDP
  - Higher revenue from property tax
    - GIMF instrument / shock: Lump-sum tax
    - Scale: ½ percent of GDP

- Wage Bargaining
  - Move to firm-level wage bargaining
    - GIMF instrument / shock: Wage mark-ups
    - Scale: 15 pp reduction
    - Mapping note: Kangur (2017)

- Other Structural Reforms
  - Higher spending on ALMPs (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: 0.36 percent of GDP
    - Mapping note: Barnes (2014)
  - Higher spending on child care (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: 0.2 percent of GDP
    - Mapping note: Barnes (2014)
  - Universal anti-poverty program (fiscally neutral)
    - GIMF instrument / shock: Higher targeted and lower untargeted social transfers
    - Scale: ½ percent of GDP
    - Mapping note: Anderson and others (2013)
  - Product market reforms
    - GIMF instrument / shock: Non-tradables TFP (equivalently price mark-ups)
    - Scale: 17 percent decline in ETCR / PMR
    - Mapping note: Barnes (2014)
  - Public administration reforms
    - GIMF instrument / shock: Aggregate TFP
    - Scale: 1½ percent increase in steady-state real GDP
    - Mapping note: Giordano and others (2015)

- Banking Sector Clean-up
  - Reduction in NPLs
    - GIMF instrument / shock: TFP shock: ¾ non-tradables and ¼ to tradables
    - Scale: 2 percent increase in real GDP over 5 years
    - Mapping note: Mohaddes and others (2017)

- Methodological references cited in mappings: Anderson and others (2013), Kumhof and others (2010)

*Source: IMF staff estimates; Box 1, "The Global Integrated Monetary and Fiscal Model (GIMF)."*

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_Source: https://www.imf.org/-/media/files/publications/wp/2018/wp1860.pdf_