Global Analysis from the European Perspective. Preparing for the world of tomorrow

How Italy can set its own monetary policies and keep the Euro

Guest post: By André ten Dam and Jean Wanningen


This article reviews an alternative option for Italy to devalue in order to deal with its economic problems, while keeping its EMU membership and the euro as its currency. Referring to the Keynes’ views, the crucial role of the rigid one-size-fits-none euro in the Italian economic malaise is analyzed. And the reason is explained why Italy needs a devaluation, in particular versus Germany. Because a euro-exit with re-introduction of the lira currency by Italy will be accompanied by several complications, disadvantages and risks, The Matheo Solution (TMS) is presented as a more suitable, simple, smart and elegant alternative. Via implementing a national unit of account for every individual euro country, the ‘lean & mean’ TMS model introduces monetary flexibility regarding exchange(value)-rate adjustment and interest rate differentiation on a national level within the Euro Pact. Keynes probably would have considered the TMS model himself, if he had the time to live. Although in 2010 intended for a Eurozone-wide implementation, Italy, then regaining the crucial parts of its monetary sovereignty, can implement the TMS model unilaterally as well. After devaluing the newly introduced Italian unit-of-account the Italian economy, employment and state finances will instantly improve.

Since the introduction in 1999 of the common European one-size-fits-all euro-currency in Italy, the third euro-zone economy is struggling. Instead of the promised growth and prosperity the common currency has thrown the country into a situation of stagnating economy, structural high unemployment and (as a consequence) deteriorating state finances. And the outlook for the future isn’t very bright either.

In this downward spiral well educated youngsters (the Italian human capital) move abroad, industrial production move to other countries with lower labor costs and the Italian banking system finds itself in a state of collapse.

Two relevant questions are:

  1. What is the main cause of the Italian troubles?
  2. What could Italy do to turn the disastrous tide?

Keynes lends a helping hand.

Keynes’s economic theories

John Maynard Keynes (1883 – 1946) taught us all last century that national economies can function best in a situation of external and internal ‘economic equilibrium’.

An important element of this is ‘mutually balanced exchange rates between countries that jointly form a border-crossing trade market’. A balanced exchange rate with the relevant foreign countries is also of great importance for the necessary balance between the export-related part and the domestic-related part of the economy of each individual country.

Moreover, Keynes explained that the currency of a country needs an appropriate interest rate level. When an economy tends to overheat with harmful increasing inflation the interest-rate should be set at a higher level to cool down the economy and control the inflation. And when an economy tends to bust the interest-rate should be set at a lower level to stimulate the economy and employment.

So in short, the full potential of each individual national economy (the ‘symbiosis’ of the export-related part and the domestic-related part) is optimally served in a situation of mutually balanced exchange rates in each country and with national-oriented (tailor-made) interest rate policies. At the same time this means that (by definition) it is harmful to a country if it has a currency which is too strong or too weak compared to the currencies of other relevant countries and/or if it has an interest-rate-level that is not economically appropriate.

The conclusion then is that the availability of exchange-rate-adjustment and interest-rate-differentiation is essential for countries with divergent economies.

Keynes also explained that business-cycles should be accompanied by regulated counter-cyclical fiscal government-policies. In times of economic downturn with declining employment, governments need to pursue a more stimulating-expansive fiscal policy and, in times of economic prosperity a more restrictive fiscal policy.

Keynes further argued that economically stronger countries should offer some (financial) aid to the economically left-behind-countries for economic development and improvement, not only out of solidarity, but certainly also because all other countries will benefit and gain interest when each and every country shows its best economic performance. An example of this solidarity is the current EU Cohesion Fund from which in particular the Southern and Eastern European EU/euro-countries have benefited. For a good understanding, the solidarity referred to by Keynes is something completely different from a full-blown European (political) transfer-union propagated by France and the European Commission.

All these monetary lessons also formed the basis for Keynes’ Bancor Plan, the British contribution to Bretton Woods (1944).

Euro lessons by Keynes: one-size-fits-none

Regarding the Euro Pact and its major problems Keynes would obviously have concluded that the rigid one-size-fits-all structure is the crucial flaw of the Euro Pact and at the same time the main cause of the economic stagnation and destruction.

Given the severe economic differences between the euro-countries in strength, development, character and economic cycles, monetary flexibility on a national level is indispensable. And, as we have seen in the continuing euro-crisis, without the availability of exchange-rate-adjustment and interest-rate-differentiation the divergence and destruction will last and even increase.

According to Keynes’ lessons, the Euro Pact thus simply needs a monetary flexible structure of internal adjustable exchange-rates and interest-rate-differentiation on an national member-state-level. Only in this way can each individual national euro-economy function optimally, regaining its resilience, and unemployment can be kept at low levels in all member-state-countries.

Obviously, an appropriate monetary structure alone does not guarantee economic success and prosperity; therefore, sound economic and fiscal policies are required as well. However, when the monetary structure is not appropriate but harmful, it will reduce long-term growth prospects and cause substantial and long lasting damage. And exactly that is the main flaw and the tragedy of the Euro-project.

Caught in the Euro Trap

So, despite its (potential) benefits (1), by introducing the common currency in the monetary rigid one-size-fits-all structure, the mutually so economically divergent euro-countries irresponsibly maneuvered themselves into the Euro Trap.

(1) The convenience of one-and-the-same means-of-payment (legal tender) and price transparency within the entire euro zone; the stronger embedment of the economically powerful Germany in the European unity; the monetary stability of the euro and the absence of currency speculation within the euro zone; the intention that the euro would evolve into a dominant international trade and reserve currency, in addition to the US dollar.

Because of this major malfunction, within the European common market the euro has developed itself into a currency that, for instance, is (much) too strong for several (weaker) Southern European countries vis-à-vis some Northern countries, in particular vis-á-vis the dominant European economic powerhouse Germany. For instance, compared to Germany, for Italy the euro is over thirty percent overvalued.

As a result, sound economic growth and prosperity in several (weaker) Southern countries are more-or-less destroyed, and sound development of the domestic-related part of the economies and the purchase-power in some Northern member-states are being suffocated.

Then from an (economic) rational point of view it would be logical and wise to dismantle the euro and return to a European exchange-rate-system based on national currencies.

Although Keynes’ lessons are common economic textbook knowledge and have proven itself in the euro-crisis daily practice to be valid, the stubborn political and monetary establishments in Brussels, Frankfurt and the member-states still refuse to listen and act.

Instead, these establishments, with a narrow-minded tunnel-vision, only desperately concentrate on saving their politically prestigious Euro-project, whatever it takes and no matter the financial, social, humanitarian and political costs. And in the meantime harmful pro-cyclical austerity policies have been imposed on the severely troubled countries.

However, because the present Italian government sharply sees that their country is crushed in the rigid Euro Pact and urgently needs a monetary devaluation vis-á-vis Germany, the Italians are now diligently looking for a workable and elegant way to escape the destructive European one-size-fits-none monetary-straitjacket in order to revive the economy and the country.

So, should Italy then perhaps opt for a unilateral euro-exit, the so called Ital-exit?

Italian euro-exit with a re-introduction of the lira-currency?

If Italy were to leave the euro and re-introduce the lira currency, then the exchange-rate of the new Italian national currency will obviously devalue relative to the euro, and in addition the Italian central bank can and will set a national interest rate at an appropriate level for Italy only. And that is exactly what Italy needs and is looking for.

However this euro-exit-scenario with re-introduction of the lira-currency involves a number of complications, disadvantages and risks. Probably the most important ones are:

    1. Leaving the euro de facto means leaving the EU and the common market as well 

      According to the EU-Treaty the euro is and can be the only currency in each and every euro-country. By leaving the euro and introducing a new national currency, Italy then would violate the EU-Treaty. This violation will de facto mean that Italy probably will be forced out of the EU and the beneficial European common market. So exiting the euro will bring Italy, that is now geographically and economically firmly embedded in the common market, in a position of vulnerable economic isolation.And given the harsh-unreasonable and retaliatory attitude of the EU towards Britain in the Brexit negotiations, it is very unlikely that the EU will facilitate Italy’s exit from the euro without having to leave the EU and the European common market as well.

    2. Monetary instability 

      A euro-exit for Italy means that the lira currency probably will exist in a floating exchange-rate regime vis-á-vis the euro (and other currencies). The exchange-rate of the lira will then be determined by the fickle and ruthless money markets, which means that the lira will be vulnerable in such monetary unstable surroundings and therefore hard to manage by the Italian monetary authorities.

    3. Overshooting devaluation 

      Given the economic fundamentals of Italy, in particular compared to those of Germany, the lira will be seen as a ‘weaker currency’ compared to the euro. So, as intended the lira will devalue relative to the euro.However, existing in an unstable floating exchange-rate-regime, there is a severe risk that immediately after the introduction of the lira its exchange rate might very well plunge through the floor, far below the equilibrium relative to the (German) euro. And a overshooting devaluation will be harmful to the Italian economy, purchasing power and inflation control.

    4. Currency speculation 

      Having its own currency, Italy might moreover be a victim target for currency speculation – remember ‘George Soros and the British pound’.

    5. The euro as an unofficial but dominant (parallel) currency 

      After a euro-exit with re-introduction of the lira, the euro will continue to play a dominant role in the Italian (daily) practice, which is a undesirable and complicated situation and as well destructive for the positions of the lira, the Italian banking sector and the Italian state finances.The point here is that, though being the official Italian currency and means of payment (legal tender), the lira will be considered as an vulnerable and instable currency compared to the euro. The consequence is that in (daily) practice the Italians will favor to be paid rather in the euro than in the lira. Such a parallel (often black) money circuit is destructive for the position of the lira (remember ‘Gresham’) and the Italian state finances. Moreover, in daily practice it is complicated – the Italians will need two wallets. Another consequence is that the euro will be dominant as a store of value (savings) outside the Italian bank deposit system, which will be destructive for the Italian banking sector and an effective Italian taxation.

    6. Payment in full of the Target2 debt 

      Early 2017 ECB-president Mario Draghi argued that if a euro country would dare/choose to leave the euro, it would have to settle its ECB-Target2 account in full at the same time. The Target2 debt of Italy is currently around € 500 billion.

    7. Chaotic and harmful bank runs and capital flight 

      It is of importance that the currency switch (euro exit with the re-introduction of the Italian lira) be kept a secret until it actually has been executed. It would probably cause chaotic and harmful bank runs, capital flight and other harmful economic and financial disturbances, if the currency switch became publicly known in advance.The problem is that in the preparatory process of the currency switch a whole new payment/clearing-system needs to be created and made operational. Moreover new lira-coins and notes have to be minted/printed and distributed. This preparatory process obviously takes time and there will be a lot of people involved. This would mean that there is a huge risk that the currency switch would leak and become public in advance, which then would cause the aforementioned chaotic and harmful situations.

Though Italy urgently needs a devaluation, given the complications, disadvantages and risks, it is therefore understandable that the Italian government is as yet reluctant to exit the euro. And because of these complications, disadvantages and risks are all ‘currency-related’, the Italian authorities should consider another, ‘non-currency-related’ way to establish an Italian devaluation vis-á-vis the euro, ….which brings us to ‘The Matheo Solution (TMS)’.

Monetary flexibility within the Euro Pact: The Matheo Solution (TMS)

The Matheo Solution (TMS) introduces the urgently needed monetary flexibility within the Euro Pact.

The TMS-model is based on the classical theory of money, and more specifically on two different functions that money has:

  1. ‘means of payment’ (legal tender), and
  2. ‘unit of account’.

It is important to emphasize that the unit-of-account function of money is precisely the money function on which exchange rates and interest rates are determined. And with a little creative thinking we then can easily imagine separating the unit-of-account function from the means-of-payment function, in order to establish the intended monetary flexibility on a national level within the Euro Pact.

The result then is that the euro can continue to exist as the single currency throughout the euro zone, including the sole means of payment (legal tender) in each individual euro country, both for cash and bank payments, while for the realization of the monetary flexibility (exchange-rate and interest-rate differentiation on a member-state level) simply national ‘units of account’ can be introduced.

This means that via a small, smart adaption of the Euro Pact, the TMS-model easily combines the euro as the single common currency and all its aforementioned benefits with the urgently needed monetary flexibility of national currencies, while at the same time it eliminates the disadvantages of both systems. Therefore we can characterize the TMS-model as ‘the best of both worlds’, advantageous to citizens and businesses in all euro countries.

So with a ‘lean & mean’ Euro Pact 2.0 according to the Matheo Solution (TMS) the prosperity in all euro countries will increase as initially intended when the euro was introduced. In addition, the traditional European political elites will be saved from ‘loss of face’ by the dismantlement of the Euro Pact.

The TMS-model can be implemented by simple European and national legislative bodies – since the euro remains the single currency and legal tender in each and every euro country, so a change of the Maastricht Treaty is not required.

With kind regards from Keynes

Interestingly, the TMS monetary structure for the Euro Pact described here brings us back to Keynes.

With his aforementioned Bancor Plan at Bretton Woods (1944) Keynes proposed an international exchange-rate mechanism for the participating national currencies with the Bancor, a supra-national basket unit of account, as the anchor. Decades later the Bancor ws a model for both the European Currency Unit (ECU) of the former European monetary system and the Special Drawing Rights (SDR) of the IMF.

However, the experiences of the ECU and the SDR have shown us that such a supranational unit of account cannot make it to be a success simply because a unit of account is not ‘dominant’: it lacks the trade (means of payment) and the reserve (store of value) function of a currency.

Realizing this, one could say that the monetary flexible TMS-model, in which the anchor has turned from a supranational unit of account into a dominant supranational currency, is the additional final step (which Keynes probably would have considered himself, if he had the time to live) to turn the Bancor Plan into a success. This final step is as well the ‘missing-link’ that can finally make the Euro Pact work and turn EMU and the euro into a lasting success.

Despite its clear advantages the European political establishment regrettably did not find yet the wisdom and common sense to consider the implementation of the TMS-model for the Euro Pact.

A unilateral implementation of TMS by Italy

Though in 2010 created and (tailor-made) designed for a Eurozone-wide implementation in each and every euro-country, Italy, then changing the ball game and regaining the crucial parts of its monetary sovereignty, could now of course implement this TMS-model unilaterally as well.

That would mean that, while it can keep the euro as its currency and means of payment (legal tender) in the country, Italy can restore its national monetary flexibility and sovereignty. It would do so simply by introducing a national Italian unit of account. Such an Italian unit of account could for instance be named ‘the ITA unit’.

Identical to an Italian national currency, such an Italian unit of account expresses the value of the price level in Italy in the euro. And by changing the value of the ITA unit relative to (the unit of account of) the euro, the Italian authorities are able to mimic a precise Italian currency devaluation vis-á-vis the euro (read: Germany).

The value-ratio regime of the ITA unit versus the euro can be characterized as a ‘fixed but adjustable’ regime, managed by the Italian authorities.

And by introducing the ITA unit Italy allows itself to set its own appropriate national interest rate as well.

The ITA unit is obviously not a new (parallel) currency, and therefore by definition neither a currency unit, but just the Italian national unit of account. And that is exactly why – and that is the game changer and the magical trick – by implementing the TMS model Italy can establish the desired Italian devaluation without having to exit the euro and without all the aforementioned currency-related complications, disadvantages and risks of the re-introduction of the lira.

TMS in Italian (daily) practice

So the TMS model restores monetary flexibility and offers real and immediate perspectives for economically sound and sustainable growth and employment, while Italy can keep its full EMU/EU and common market membership.

How would the TMS model exactly function in (daily) practice?

Obviously, for the introduction of the TMS-model no new national coins or notes need to be minted/printed – all cash and bank payments, domestically in Italy and cross-border to/from other euro-countries – will continue to be done in the euro. So as usual the wallets of the Italians will only contain euros, and the Italian (non-interest-bearing) bank payment accounts will continue to be denominated in the euro.

The Italian domestic prices, wages and contracts will be calculated and denominated in the ITA-unit which will be in a certain (fixed but adjustable) value ratio relative to (the unit of account of) the euro. Italian (interest-bearing) bank deposit accounts will be denominated in the ITA unit as well. And because of the introduction of the ITA unit for Italian domestic purposes, we may see double price tagging in shops (both in ITA unit and in euro), identical as during the introduction time of the euro.

In accordance with the implementation legislation all new cross-border (trade) contracts governed by Italian law will be calculated and denominated in the ITA unit as well. And given the ‘Lex Monetae principle’, all existing cross-border (trade) contracts governed by Italian law and denominated in the euro will be converted into the ITA-unit.

Since the euro remains the only currency and means of payment (legal tender), the unilateral introduction of the TMS-model can take place without Italy being forced to exit the EU and the European common market. After all, for implementation of the TMS-model a change of the Maastricht Treaty is not required (the euro remains the single currency and legal tender), it will be subject to Italian decision-making and legislation only.

And because no new currency coins and notes are needed, the unilateral implementation of the TMS model by Italy requires very little preparation. A simple software adjustment for the financial sector will do the trick.

Adjusting the value rate of the ITA-unit relative to the euro works as follows: At a chosen moment (the first time a blink after the introduction of the ITA unit), the Italian (monetary) authorities adjust (devalue) the ITA unit relative to (the unit of account of) the euro in order to restore and very precisely re-balance the Italian real economic strength versus that of Germany. That devaluation will have similar consequences and advantages as a traditional currency adjustment: it decreases the prices of Italian products abroad, and the costs for foreign tourists visiting the Italy, thus stimulating the Italian economy and employment and improving the Italian state finances and solvency of the Italian banks.

It needs no further explanation that, in the resulting immediate economic and financial recovery, there will arise a much better democratic, social and political foundation for implementing necessary reforms. And, though the devaluation will improve the Italian state and banking finances, a partial write-off of the unsustainable Italian national debt and a recapitalization of several Italian banks will remain necessary to complete the Italian recovery.

Since all domestic prices and wages are set in the ITA unit, with a devaluation they all stay at the same level expressed in ITA unit but decrease in euro. Only the prices of imported goods will increase in ITA unit, which will benefit the sales and production of similar Italian-made goods, exactly in line with the competitiveness advantages for Italy of a currency-devaluation.

Because in the TMS model the ITA unit is not a (parallel) currency but just a unit of account, it cannot be purchased or traded. Together with the ‘fixed but adjustable’ value regime of the ITA unit vis-á-vis (the unit of account of) the euro that means that there is no risk whatsoever of an ‘overshooting devaluation’ or ‘currency speculation’. Especially that makes the TMS model a very attractive option for policy makers and central bankers who usually tend to be quite nervous about currency risks.

Determining the value rate of the ITA unit

Just as the unilateral introduction of the TMS model will be Italy’s sovereign decision, so will the percentage of the initial devaluation of the ITA unit relative to the euro be determined by the Italian central bank, possibly in cooperation with the Italian finance minister. After this initial substantial devaluation, with time, new devaluations or revaluations might be appropriate.

With a well-balanced value rate of the ITA unit relative to the euro (read: Germany), Italy can establish and sustain the optimal position between international competitiveness of its economy and domestic purchasing power, which serves the prosperity of the Italian people and businesses best.

This optimal value-rate will be determined by the so-called purchasing-power-parity assessments.


Italy is at present in a survival mode: it urgently needs to create sound and sustainable economic growth in order to better employ its labor population, decrease the budget deficit, reduce the number of the non-performing loans in its banking system, and offer new perspectives to the people.

By introducing the TMS model, a sovereign Italy can escape the suffocating one-size fits-none euro straight-jacket and will immediately create a revival of its economy, employment and finances, while keeping its full EMU/EU and common-market membership.

The other euro countries, in particular the economically vulnerable ones, will closely observe what will happen. ….And such unilateral action by Italy could very well be the crowbar for a euro-zone-wide implementation of the TMS model, so that we finally can all live happily ever after.

André ten Dam is a Dutch independent euro-researcher and monetary engineer. Early 2010 he developed the TMS-model –

Jean Wanningen is a Dutch euro-watcher and financial publicist, among others on the leading Dutch financial research journalistic platform Follow The Money (FTM). In 2014 as the author he published the book (in Dutch) ‘Het Eurobedrog’ (The Euro-treason) – @trias_politica.


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