The report discusses the relevant factors that in the opinion of the government should be considered when assessing Italy’s compliance with the Stability and Growth Pact. The first is the persistence of deflationary pressures. Consistent with virtual price stability, nominal GDP growth has been weak, hindering a significant reduction in the public debt ratio. The decline in bond yields supported debt stabilisation, but Italy’s implicit interest cost declined only gradually due to a high financial duration of public debt. Looking forward, worldwide excess capacity and strong competitive pressures are still bearing down on prices. Given this outlook, the government judged it appropriate to aim for gradual deficit reduction in 2017 while targeting faster consolidation in 2018-2020. The second key factor is that Italy’s output gap is grossly underestimated. Despite a sharp output loss compared to 2008, an unemployment rate of 11.6 percent and virtual stability in wages and prices, the Commission estimates that Italy’s output gap will shrink to a mere 0.8 percentage points of GDP in 2017 and zero in 2018. The report presents alternative output gap estimates based on the ‘commonly agreed methodology, which suggest the gap remains close to 3 percent in 2017 and, crucially, will close more gradually than suggested by the Commission over the coming years. Thirdly, Italy’s reform effort continues. The effect of recent reforms is estimated at 2.2 percentage points of GDP by 2020, 3.4 points by 2025 and 8.2 in the long run. Other highly relevant factors include Italy’s track record of fiscal discipline and the budgetary impact of the ongoing immigration wave and of the recent earthquakes.[…]