Vicious circles: The interplay between Europe's financial and sovereign debt crises

Briefing 06-06-2016

From 2007 a series of crises in the economic and financial sphere hit the European Union. These were partly linked and tended to amplify each other. Two of the hardest hitting, the financial and sovereign debt crises, were closely intertwined and put immense pressure on the euro area, stressing the financial sector and pushing Member State governments' budgets to their very limits. Several Member States lost access to the capital markets, and required financial assistance from both the euro area and the IMF. Unlike the United States economy, the euro area economy has failed to bounce back from the economic crisis owing to its ongoing sovereign debt crisis. Although the initial shock of the financial crisis came from the United States of America, the crisis took a different twist in the euro area, which was not prepared for such an event. There were no proper crisis resolution mechanisms in place, nor were there sufficient budgetary margins available to save the banks and reinvigorate the economy without putting the sustainability of public finances in jeopardy. The Stability and Growth Pact, a central element of Economic and Monetary Union, had failed to produce the necessary fiscal margin. Problems were compounded by macroeconomic imbalances that had built up inside several Member States. The European Union fought on two parallel fronts: saving banks and supporting stressed sovereigns in order to extinguish the fire, while also correcting the framework with the aim of avoiding a recurrence of similar crises. Although the worst seems to be over, problems persist and a renewed flare-up is not impossible.