Critically analyse how the government debt problems initially faced by Essay

Critically analyse how the government debt problems initially faced by a few relatively small economies could trigger such a wid - Essay Example The issues referring to the economies affected by the crisis shall also be discussed in this paper in order to establish the impact of sovereign debt to the euro financial crisis. This paper is being carried out in order to establish an academic and analytical discussion of the European crisis, linking its causes with its eventual impact on a larger economic region. Body The European crisis significantly impacted on the European financial market. Various elements colluded in order to cause the European crisis, with the crisis more or less unfolding in smaller economies, including Greece, Portugal, and Ireland. The money market was significantly affected by the deterioration in market conditions which started in 2007 (European Central Bank, 2012). The interbank markets are usually subjected to counterparty risk. The collapse of Lehman Brothers in 2008 led to lower confidence in the market, which then caused issues in financial integration (European Central Bank, 2012). Such event trig gered the increase in cross-country dispersion in overnight rates, as well as lower interbank market activity. Although measures to address market tension were implemented by the European Central Bank, the tension re-emerged in 2010 due to pressures in euro government bond markets (European Central Bank, 2012). More remedies were implemented by the ECB which helped improve the money market in the euro area. However, in 2011, more pressures on the euro sovereign bonds caused issues in market integration. Such deterioration also became apparent in the secured financial market. In 2011, the ECB once again introduced remedies to ensure liquidity support for financial institutions (European Central Bank, 2012). Price-based remedies implied deterioration in the integration of the money market, specifically for short maturities. Integration gains which were expected after the bailouts were reversed by the crisis. With longer maturities, the measures of integration seemed to be stable; howe ver in 2011, these measures actually indicated deterioration (Dadush, et.al., 2010). The sovereign bond markets went through significant tension in 2011. During the onset of the financial crisis in 2010, only three smaller countries were severely affected; however, in 2011, the larger countries were soon affected, especially in terms of their bond yields (European Central Bank, 2012). Moreover, market declines in sovereign yields could not be reached with the implementation of fiscal adjustments, as in the case of Ireland. Improvements in the sovereign bond market were evaluated based on simultaneous movements in yields. Europe for the past 2-3 years has been faced with a very serious crisis (European Commission, 2010). The bond market has already been closing to the euro-area countries, and for those who are still open, they are charging high rates of interest for any loans or investments. The increase in bond yields is based on the fact that where investors view more significant r isks associated with their investments in a country’s bonds, they would also likely need higher returns in compensation for such risks (European Commission, 2009). An unfavourable cycle often ensues from this situation as the demand for higher yields would lead to higher costs in borrowing for the country. This causes financial issues