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Over the weekend, Italian President Sergio Mattarella exercised his right under the Italian constitution to block Paolo Savona from serving as minister of the economy in the proposed coalition government of the 5 Star Movement and the League. Savona presciently warned that the euro area’s budget rules needlessly choke off infrastructure spending in recessions and has also written thoughtfully about banking regulation.

After the coalition failed to come up with a replacement, Mattarella appointed Carlo Cottarelli to be the new prime minister until new elections can be held. Cottarelli spent most of his professional career at the International Monetary Fund, most recently as the director of the Fiscal Affairs Department, where he earned the nickname “Mr. Scissors.”

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Mattarella justified these moves, which were not unprecedented, on the grounds that “defending the Constitution and the interests of our national community” requires him “to pay great care in protecting the savings of Italian citizens.” Savona wants his country to have a “Plan B” to reintroduce its own currency in response to a future crisis. To Mattarella, this is equivalent to “a line of reasoning, often manifested, that could probably, or even inevitably, provoke Italy’s exit from the Euro.”

This would be bad, according to Mattarella, because he believes the act of leaving should be a deliberate decision only taken “after a serious in-depth analysis” and open debate. Since the issue “was not brought up during our recent election campaign,” it could be considered undemocratic for the majority parties to inadvertently impose euro exit on the Italian people.

Mattarella is wrong. His thinking reveals a fundamental misunderstanding of currency regimes and of banking crises.

Regardless of whether Italy should stay in the euro, the decision to do so cannot be taken in isolation. While membership in the monetary union effectively constrains national economic and financial policy on a range of dimensions, those constraints are not inherently fixed. Instead, they are products of political choices. Different choices could produce different constraints. The case for leaving the euro therefore depends on the gap between what is best for any individual country and the arbitrary constraints imposed on that country from outside. This cannot be known in advance.

The economic policies proposed by the 5 Star/League coalition are ambitious but reasonable. The combination of tax cuts, welfare reform, infrastructure spending, and anticorruption enforcement should have a meaningful impact in a country where unemployment is still about five percentage points above where it was before the crisis. The Financial Times’ Martin Sandbu argues this policy mix is such a good idea, it should be coopted by Cottarelli “against what are no doubt his instincts.”

The uncertainty is whether the agenda would be tolerated by Italy’s neighbors. The problem, as I discussed in a previous column, is that two features of the eurozone make severe crises inevitable without the active intervention of the European Central Bank:

• Real government borrowing costs go up in recessions.

• Bank accounts in one euro area country are just as good, if not better, than bank accounts in any other member state.

The toxic combination means that individual countries are perpetually at the mercy of decisions made by a few unelected officials in Frankfurt, although the leverage extends only to economic policy. This was demonstrated in the Greek crisis in the summer of 2015.

As the Greek government attempted to renegotiate the terms of its loans from the European Stability Mechanism, Greeks started pulling their savings out of their local banks. The textbook response to a bank run is for the central bank to provide emergency loans to fundamentally healthy banks and wind down the others. Just a few months earlier, the ECB had declared that most of the big Greek banks were solvent, so those lenders should have been given emergency loans to offset the deposit flight.

Yet that is not what the ECB did. Emergency lending was capped and deposit flight accelerated. To prevent the banks from collapsing, the Greek government imposed capital controls—a particularly painful decision given Greece’s cash-intensive economy. (Cyprus also had to close its banks to stay in the euro in 2013.)

The only viable options were: 1) Capitulate to foreign demands in exchange for restoring ECB loans to the Greek banks, or 2) Leave the euro to print new currency and save the domestic financial system. To decide, the Greek government called a referendum on whether to accept the terms offered by the rest of the euro area.

Yanis Varoufakis, the finance minister at the time, had tried to prepare for a euro exit in the event the voters rejected the available deal, but was overruled. The result was that the Greek government was forced to capitulate even after the voters decisively expressed the opposite preference. Popular desires were blocked by a lack of planning. Looking back, Varoufakis notes that “no prudent finance minister would neglect to develop a plan for euro exit” even if the hope is never to resort to such a drastic measure.

This applies just as much to Italy today as it did to Greece three years ago. Italy is bigger than Greece and may have some extra clout as a founding member of the European project, but it is still vulnerable to capital flight and bank runs if its “partners” ever disagree with the economic policies of the Italian government. The situation could be especially dangerous if someone such as Jens Weidmann, currently the head of the Bundesbank and a front-runner to replace Mario Draghi, ends up in charge of the ECB at the end of next year. Any responsible Italian government should therefore have a contingency plan.

After all, despite the potential for longer-term benefits, exiting the euro would be costly at first. (The single best guide to understanding the process was written by Roger Bootle of Capital Economics nearly six years ago.)

The Italian government would have to ban cash withdrawals until the new currency could be coined and printed. People and businesses would also have to be temporarily prevented from shifting deposits abroad. Italian government debt and bank deposits could easily be redenominated into the new local currency by passing a law overnight, but changing other contracts could be more challenging. Some debts would have to be defaulted on because they would become extremely expensive to service as the new currency depreciates against the euro.

The trickiest of these obligations would be the roughly €450 billion that the Bank of Italy owes to the rest of the euro system through its Target2 balance. This debt is currently backed by collateralized loans to Italian banks and by holdings of Italian government bonds bought through the ECB’s asset purchase program, but those assets would not retain their value in euros after an exit.

There would also be distributional issues. People with physical euros, real assets, and foreign investments would all experience a significant increase in their net worth. Many of those are already wealthy and/or tied to criminal organizations. Exporters would benefit from the widening difference between their foreign currency earnings and their locally denominated costs. Others, especially those on fixed incomes and those reliant on imported inputs, would do less well.

All of these costs would rise if leaving were preceded by an electoral campaign predicated on Italy’s membership in the euro area. The mere possibility of leaving would encourage every Italian to pull money out of the banking system and sell domestic financial assets before capital controls and redenomination kicked in. Even if the Bank of Italy were allowed to help, this would simply increase the eventual cost of leaving by running up the tab with the euro system. If the Bank of Italy were blocked by the ECB, Italy would be forced to leave the euro regardless of what voters would have decided. At that point, it would have been particularly unwise to have gone into the situation without a comprehensive plan for euro exit.

Mattarella may have sincerely thought he did the right thing by blocking Savona’s appointment. But his stated argument makes no sense. While leaving the euro is not desirable in itself, being prepared for the possibility is necessary to be able to implement optimal economic policy.

Email: matthew.klein@barrons.com