How likely is it that the forthcoming decision of the Parliamentary Committee to ban Silvio Berlusconi from the Senate will lead to a political crisis, prompting a strong rise in Italian yields? In my opinion, the probability today is slightly above 50%. Rather than hinging upon the survival of the Letta government, however, the likelihood of a rise in the spread depends on the fate of the electoral law reform: Will the electoral law be reformed in such a way that produces a stable majority, before the elections? I outline my views of the situation below.
I give a very high probability (say, 100%) to the Committee deciding to ban Berlusconi from the Senate: This is because any other decision by the Democratic Party, which holds a majority in the Committee, will lead to the party’s dissolution.
Given that, there two scenarios (see figure): either the center right prompts the fall of the Letta government or it does not. This is depends on how Berlusconi sees his chances if new elections are held. Given the relatively good recent polls, I give the the “Letta fall” scenario an 80% probability.
Under this scenario, there are again two possibilities: A new majority is formed (50% probability) between the Democratic party and the “wets” from the center right or Grillo’s M5S movement, or no coalition is formed (50%). In the latter case, new elections are scheduled in accordance with the existing electoral law.
If a new majority is formed, the new coalition may produce a new suitable electoral law (70% probability) or fail to reach an agreement on the overhaul (30%), resulting in elections being held under the old rules.
Summing up, the “optimal scenario”—in which no interest-rate spikes occur—would be one in which either the Letta government survives or a new majority agrees on suitable electoral reforms. Doing the math gives this scenario a 48% chance. The bad scenario—where elections are eventually held under the current electoral law—has a 52% probability.
This piece is cross-posted from Back-of-the-Envelope Economics with permission.