Does It Pay to Have the Euro? Italy's Troubled Politics and Financial Markets under the Lira and the Euro

There is a broad consensus that the quality of the political system and its institutions are fundamental for a country's prosperity. This paper focuses on Italy's troubled politics over the past 35 years and asks whether the adoption of the euro in 1999 has helped insulate Italy's financial markets from the adverse consequences of its traditionally unstable political system. We find that important political events have exerted a statistically and economically significant effect on Italy's financial markets throughout the 1970s, 1980s and 1990s. The introduction of the euro appears to have indeed played a major role in insulating financial markets from such adverse shocks. The findings of the paper therefore suggest another important economic dimension and channel through which Italy may have been affected by EMU. Our analysis could also be potentially interesting for other countries with weak institutions considering adopting a currency based on stronger institutions.