Unfortunately, the vicious cycle between the economic health of countries and the weakness of their financial systems has been all too evident over the past year.
Think of Spain. Before the crisis, the country’s debt-to-GDP ratios were among the lowest in the eurozone. But the state of its regional banks, the cajas, has pushed the sovereign’s borrowing costs to euro-era highs, far above the levels seen in members of the single currency with far higher levels public indebtedness. In Greece, the government’s fiscal profligacy is at the root of the problems befalling the country’s financial sector, in part because its banks held so much sovereign debt.
In both countries, the economy is stagnant.
So far, central banks have been called upon to stop the cycle turning even more vicious. But central banks’ actions can only buy time; the ECB’s pledge of a whopping €1trn in cheap three-year loans, revolutionary in every respect, only soothed tensions for a few months.
The Bank for International Settlements has long documented the vicious cycle phenomenon (see here, for instance). In its latest annual report, out Sunday, the so-called central bankers’ bank comes up with a prescription on how to cure it. Read more