From the American Financial Meltdown to the European Banking and Public Debt Crises

In this chapter, we analyze how, via the banking system, the financial contagion was extended from the US to Europe. In fact, we observe the extension of the Great Crisis from the international banking system to the European sovereign debts. The problem is that the expansionary fiscal policies of deficit spending implemented by most States to tackle the crisis have created very large deficits, which are difficult to adjust in the short run. To save banks, private debt became public debt. At the same time, with deteriorating public finances, sovereign risk has increased and worsened bank’s balance sheets. In fact, in European countries it is really a sequence of interactions between sovereign problems and banking problems. The genesis of these interactions also focuses on the imbalances in European Monetary Union (EMU) countries balance-of-payments. The European crisis has shown that it can spread quickly among closely integrated economies, either through the trade channel or the financial channel, or both.