After the collapse of Lehman Brothers in October 2008, the turmoil mutated into a full-blown financial “crisis” and many market segments seized up. The “Great Moderation” gave way to the “Great Recession”, characterised by a massive fall in industrial output and trade. BIS central bankers’ speeches  1  Policy interventions were made by central banks and other public authorities to restore and secure the orderly functioning of markets and economies. I like to think of the interventions by public authorities as “lines of defence” against the crisis. They proved successful in guaranteeing those authorities’ ability to continue delivering macroeconomic and financial stability against the crisis. Let me recall briefly the three main lines of defence: central banks increased their provision of liquidity and financial intermediation services; monetary and fiscal authorities adjusted their policies in order to mitigate the macroeconomic impact of the crisis; and governments implemented a variety of measures in support of the financial sector. The government measures adopted in response to the economic crisis – both those related to fiscal policy and those in support of the banking sector – did not come cheap. This is true not only in the euro area, but – more generally – in all advanced economies. Together with the impact on government budgets of the massive economic contraction recorded during the crisis, they led to a significant deterioration in the public finances of a number of economies in the euro area.
The deterioration was particularly significant in countries in which: (1) pre-crisis growth had been of an unsustainable and unbalanced nature – typically as a result of an over-reliance on the expansion of private credit and the contributions of housing-related sectors (notably construction and housing finance) – and (2) in which governments had failed to take advantage of favourable developments in the years of booming growth in order to consolidate their public finances. Over time, concerns about the size of government deficits and soaring debt-to-GDP ratios – combined with uncertainty about the ability of governments to design and implement consolidation plans in the context of reduced potential growth and massive implicit liabilities towards the financial sector – developed into uncertainty about the sustainability of government debt. Although the initial problems primarily concerned the Greek government debt market, contagion and spillover effects meant that the crisis quickly spread to the sovereign debt of other so-called “peripheral” countries and other market segments. In particular, financial markets turned their attention to the solvency of some “peripheral” economies that were perceived to have been hit particularly hard by the crisis because of long-standing structural and institutional weaknesses. The deterioration of public finances in some euro area member States has impacted negatively on investors’ confidence in government bonds issued by these countries, and thus led to further turbulences in the financial markets. This is also reflected in the sharp increase in the yields on the government bonds issued by those countries.