The Other Crisis: Sovereign Distress in the Euro Area
The Other Crisis: Sovereign Distress in the Euro Area
This chapter examines the roots of the sovereign debt crisis in the euro area (EA), with particular emphasis on why it affected the EA but not other large advanced economies. It first considers the cross-country heterogeneity in fiscal performance across the EA in the pre-crisis era, along with specific institutional and market failures that hampered fiscal convergence and amplified vulnerabilities. It shows that deepening intra-EA imbalances and rising fiscal vulnerabilities in the first decade of the euro had planted the seeds of the crisis. When it broke, delays in elaborating a regional response undermined confidence in the EA's capacity to act as a policy entity. A concentration on fiscal adjustment, combined with banking sector weaknesses and lagging growth-supporting structural reforms, engendered negative feedback loops among fiscal consolidation, banks' balance sheets, and growth. The consolidation effort was further complicated by the adoption of nominal targets in the context of the European Union's fiscal framework, which emphasized fiscal policy's procyclical bent. The chapter concludes with an analysis of lessons learned and the way forward for the EA.
Keywords: sovereign debt, debt crisis, euro area, fiscal performance, euro, fiscal adjustment, banking, structural reforms, fiscal consolidation, fiscal policy
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