The European Court of Human Rights had ordered Italy to act in January, criticizing the country for one of the worst overcrowding problems in the EU.
According to prison rights group Antigone, there are currently 142 inmates for every 100 places.
"This is not a measure to empty prisons...but simply to prevent some three to four thousand people who do not pose a social risk from ending up in prison," Italy's Justice Minister Anna Maria Cancellieri said earlier.
The new law means those accused of crimes which would be punishable with a prison sentence of five years or less will no longer be remanded in custody to await trial - apart from those suspected of illegally financing political parties.
Some 40 percent of people incarcerated in Italian prisons are being held on remand while they wait for their trials to start.
Repeat offenders - apart from those convicted of mafia association, stalking or child abuse - will also no longer automatically end up behind bars, but will be eligible to request community service or house arrest.
And criminals may be given reductions in their jail sentences from the beginning of their incarceration, rather than at the end as before.