When the papers collected in this issue of Recherches Economiques de Louvain were discussed in the Conference on the Italian Economy held at Louvain-la-Neuve in July 1974, Italy was running, together with the UK, a record balance of payments deficit, her creditworthiness was at a low ebb in international financial markets, and she was experiencing, after Japan, the highest inflation rate among OECD countries. These problems were compounded by an extremely weak political situation, managed by a Government that, after having resigned, had been sent back to Parliament for lack of an immediate alternative.

During the post-war period, and particularly after 1970, one of the main characteristics of the Italian economy has been a strong growth in financial intermediation. The financial assets in the whole have been increasing with an elasticity to money income much higher than one — and in particular the money base and the money supply have been growing with an elasticity of 1.5. In 1951 the ratio of the flow of financial assets to national income was 9 % and reached nearly 30 % in 1973.

1. The problems of economic policy in Italy at the present moment must be examined within the wider international, and especially European context. Now, as never before, the direction, the intensity and the timing of internal policies has come to depend on external variables. But such variables are not entirely “acts of God”; they are to a large extend due to international economic policies and to domestic policies in other countries. I wish to concentrate on how this interdependence of national and international policies has worked. I submit that it has worked perversely and that such perversity could, and perhaps still can, be avoided.

To discuss the problem of international interdependence of prices it is advisable, first of all, to distinguish between short-run and long-run changes. Such a distinction may be based on the usual assumption that plants and other fixed assets are given in the short and variable in the long run; this distinction, however, may be supplemented by the notion that fixed assets may vary even in the short run, but, if so, they vary as a consequence of decisions taken in previous periods, so that in the short run variations in fixed assets (and in productive capacity) are to be considered as externally given. In practice, the year-to-year data can be taken as the empirical counterpart of short-run changes, whereas pluriennal (two or three-year) moving averages can be taken as the counterpart of long-run changes.

The neoclassical model of consumer behavior, hereafter generally called utility theory, both serves as the basis for modern welfare theory and draws some of its support from the usefulness of that theory to the economics profession. Modern welfare theory, however, posits a direct correspondence between market behavior and individual welfare, a correspondence that does not exist in modern market economies. In such economies, where information is imperfect and learning is important, utility theory also fails to describe or to facilitate analysis of important aspects of consumers' behavior. Thus it provides neither a sound normative theory nor a generally useful positive theory of consumer' behavior. These assertions are amplified and defended in Sections I - III below.

1. A common pattern in the discussion on the usefulness of a theory is the following. The sceptic narrows down the theory to some statements taken from, at best, a textbook or, at worst, the newspapers and then shows that this theory has no empirical validity. The case for the defence amounts to widening the theory, making it more general, and trying to show that this generalized theory is consistent with the facts. In the limit the theory has become so general that it has lost all predictive power. The discussion is made lively by accusations of unfair representation, lack of understanding, logical inconsistency, conservatism, iconoclasm. Happily, it is only ink that flows and not blood. The whole affair is rather sterile, but so are other pastimes of less scientific nature.

Essentially the same mathematical formulations of the wage and price equation have been used in recent theoretical work by Artis [1971] and Rothschild [1971] to illustrate the circumstances under which there is no long run trade-off between the rate of wage inflation and unemployment.