The European Twin Sovereign Debt and Banking Crises

Europe currently faces a severe economic and financial Great Crisis. It is often described as a sovereign debt crisis, but in fact, it is really a sequence of interactions between sovereign problems and banking problems that caused a severe economic slowdown. It also caused a fragmentation of euro-area financial markets. The genesis of the crisis focuses on the imbalances in European Monetary Union (EMU) countries balance-of-payments, where the TARGET2 payment system became crucial, reflecting stress in the funding of banking systems in crisis-hit countries. The decisions by European leaders to set up a banking union and the announcement, as well as adoption, of non-standard measures by the European Central Bank (ECB) greatly contributed to restoring confidence in the euro-area financial markets, improving market sentiment and reversing the earlier trend towards market fragmentation. Ultimately, an expansion of the European aggregate demand is necessary to promote growth, and to this aim, the role of Germany is crucial.