Please do not shoot the wrong enemy

This work analyses external imbalances across Europe using data on sectorial gross value of assets over sixteen years (1995-2011) in founder countries of the European Union and in the whole Euro area. The empirical analysis strongly supports arguments against the thesis that in Europe sovereign debt is the problem and fiscal austerity the solution. On the contrary, it suggests that the current crisis originates from the growing disproportion of the financial sector compared to real sectors of the economy. This study divides the financial assets generated by the domestic financial companies and by the foreign sector into two aggregates: financial resources channelled to the real domestic sectors and ‘financial assets overhang’ held within the financial and foreign sector. The financial assets overhang, which boosted the relative size of the financial sector across the continent, should be considered as the main source of excess finance to be rigidly constrained.