Now, Italy

There was nothing unpredictable about the financial crisis now threatening to engulf Italy and perhaps bring down the euro. Economists and analysts have been writing about it for months, but Italian politicians, starting with Prime Minister Silvio Berlusconi, did almost nothing to head it off. And European leaders like Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France did far too little to prepare for it.

This week, the long predicted storm broke, sending Italian interest costs above 7 percent and triggering stock market sell-offs around the world, Wall Street included. Italy, the euro-zone’s third-biggest economy, after Germany and France, is too big to be rescued by the European bailout fund and too big to fail without, most likely, taking down the euro itself. Italy’s essential problem is not high deficits, or even high debt, but years of dismally slow growth, which makes the debt harder to pay off and investors more skeptical about its continued ability to repay. That’s why interest rates are rising, compounding the repayment problem.

The only European institution still potentially capable of halting this cascading crisis is the European Central Bank. Only the central bank can print euros in unlimited quantities and use them to buy enough Italian bonds to bring the interest rates down from more than 7 percent to more sustainable levels. Essentially, the bank must become the lender of last resort, printing as much money and buying enough Italian debt to stabilize the situation to allow time for longer-term remedies. While such a move cannot guarantee an end to the panic selling of Italian bonds, it is perhaps the only option left.

Until now, the bank has hesitated to play this role because it has no clear authority under European Union rules, but there are no clear prohibitions against action. Chancellor Merkel and President Sarkozy, having failed so miserably to prevent this crisis, should be publicly urging the central bank’s new president, Mario Draghi, to take these necessary steps. Yet they are still making electoral calculations that will be beside the point should Italy succumb to the debt crisis and the European Union slide into deep recession. Their refusal to think and act responsibly is having a damaging effect on world markets.

Even as European leaders preach hard-line austerity, it has failed miserably. The only way debtors will be able to repay their obligations is through faster growth. For Italy, that means quickly passing next year’s budget and installing a government able to enact reforms that encourage growth, like liberalizing labor markets, reducing bureaucracy and making public companies more efficient.

Mr. Berlusconi’s most likely successor, Mario Monti, a well-regarded economist and former European commissioner, will have to sell these reforms to Italians, who have lost trust in the Berlusconi government to do anything.

In this emergency, the European Union needs leaders capable of learning from past mistakes and changing course before it is too late to save the euro and the European Union itself. A disastrous outcome is not inevitable, but is not beyond imagination, either.

NYT