The authorities in Filettino, 100km (70 miles) east of Rome, are protesting against austerity measures.
It has only 550 inhabitants and under new rules aimed at cutting local administration costs it will be forced to merge with neighbouring Trevi.
Town mayor Luca Sellari, who stands to lose his job because of the eurozone crisis, came up with the idea.
He created his own currency, called the Fiorito. Banknotes have his head on the back, and they are already being used in local shops and being bought as souvenirs by tourists who have started to throng the normally quiet streets.
The mayor says there is enormous enthusiasm about declaring the independence of the new principality.
There has been such an outcry by small towns across Italy at the government move to abolish local councils and merge them with larger towns that Prime Minister Silvio Berlusconi's coalition may be forced to backtrack.
In the meantime the new Principality of Filettino - complete with coat of arms and website - is suddenly enjoying international fame.
TV stations from as far afield as Russia have been running news features about Filettino.
After all, the mayor says, Italy was once made up of dozens of principalities and dukedoms. As he says, the landlocked republic of San Marino still manages to survive, so why not Filettino?