Finally, prices in the non-tradable sector also ran ahead of actual increases in productivity during the boom years, leading to real effective exchange rate misalignments. The ensuing, persistent losses of competitiveness translated into an accumulation of external imbalances. The facts of the Lehman collapse in late 2008 and the subsequent sovereign crisis in mid-2010 onwards are well known.
As financial markets realised that the combination of high private indebtedness, external imbalances and structurally weak fiscal positions was unsustainable, a “sudden stop” occurred. Private cross-border financial flows dried up, bank lending collapsed and spreads increased sharply in the countries most affected by the crisis.