Introduction:

Italy adhered to the European Monetary Union (EMU) after a period of intense macroeconomic instability thanks to a rapid and incisive change of policy regime. After decades of public budgets and wage setting indiscipline, the ‘liberal’ governments of the mid 1990s succeeded to reevaluate and anchor the exchange rate, to stop wage increases, to adjust public deficits and slow down inflation. This allowed Italy to join the EMU, having satisfied the Maastricht criteria, and regained the confidence of European partners. After some years of EMU, however, some concerns, that the change of macroeconomic regime has not produced a definitive discipline to the Italian economy, are diffusing again in Europe.

In this chapter we will analyse the extent of divergence between the main Euro zone countries and highlight the dynamics which produce such strains. In particular, we will question the effective functioning of price and wage flexibility adjustments which are presupposed in the present EMU framework. The main findings are that such channels are not working as expected and that some self-reinforcing process of divergence is in place. This process depends both on the EMU and national institutional frameworks. Institutional reforms directed towards the flexibilisation of labour markets are not obtaining the expected results. Moreover, German policies aimed at increasing competitiveness by controlling wages are exporting tensions among its trade partners in the EMU.