The Irish financial situation is relatively extreme, and as such illustrates clearly some of the key problems that have been faced also in other stressed parts of the euro area. While it has delivered a much lower inflation rate, the euro is no longer insulating financial markets from the impact of excessive debt in member countries.
The early insulation of the monetary transmission mechanism from fiscal problems of participating countries has worn through. The pernicious feedback loop from banks to sovereign and from sovereign to banks that re-emerged in the crisis remains strong and damaging. Getting back to the “good” equilibrium will require a healing process which removes the market’s fear of default.