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Financial and Fiscal Interaction in the Euro Area Crisis: This Time was Different

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European Economic Review, Volume 119, October 2019 [Link] Working Paper [CEPR wp]

Article on Vox "The financial origin of the euro area fiscal wound" [Link]

Billet de blog pour l'OFCE (FR) «L’origine financière de la blessure budgétaire de la zone euro» [Link]

This paper highlights the anomalous characteristics of the Euro Area `twin crises' by contrasting the aggregate macroeconomic dynamics in the period 2009-2013 with the business cycle fluctuations of the previous decades. We report three stylised facts. First, the contraction in output was marked by an anomalous downfall in investment, while consumption, savings and unemployment followed their historical relation with GDP. Second, households' and financial corporations' debts, and house prices deviated from their pre-crisis trends. Third, the jump in the public deficit-GDP ratio in 2008-2009 was unprecedented and so was the fiscal consolidation that followed. Our analysis points to the financial nature of the crisis as a likely explanation for these facts. Importantly, the `anomaly' in public deficit is in large part explained by extraordinary measures in support of the financial sector, which show up in the stock-flow adjustments and reveal a key interaction between the fiscal and the financial sectors.

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