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Nornagest comments on Politics is hard mode - Less Wrong Discussion
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A more precise description of the Italian system is: if the centre-right coalition comprises 40% of the parliament, the centre-left coalition comprises 45% of the parliament, and the lone contrarian party comprises 15% of the parliament, then the lone contrarian party gets to decide everything (except questions on which the centre-right coalition and the centre-left coalition agree, which aren't likely to be voted on in the parliament in the first place) without needing to be in a coalition, and hence without needing to be sane enough to be in a coalition. (BTW, nobody actually likes the centre-right coalition or the centre-left coalition: people vote for the centre-right coalition just because they dislike the centre-left coalition and don't want it to get a plurality of seats and vice versa.)
(I'm not familiar with German politics so I don't know what prevents this dynamic from occurring there too.)
How often do the center-right and center-left coalitions look the crazy thing the lone contrarian party wants to do, go "lol, nope" and make a centrist compromise with each other? Is that possible/common?
The trouble with being a kingmaker is that you can't choose the people that have a shot at becoming king. The lone contrarian party isn't in a position to dictate terms; all it can do is decide whether it wants the country to be center-left or center-right on a given issue, which sounds okay for preventing partisan insanity but bad for coherence on anyone's part.
I can only see compromise being a winning move if one of the mainstream coalitions wants to do something that won't work without agreement between several different policy domains, and if it's willing to sacrifice a lot to get it. Otherwise there's no incentive: pissing off the crazies isn't a good strategic move if it implies concessions to your real enemies.