The euro area is experiencing a crisis related to financial, fiscal and economic stress in several countries. Excessive imbalances built up during the upswing and during the crisis led to a renewed bout of financial instability starting in mid-2011 and a slump in demand. The weakening position of some private and government balance sheets undermined bank portfolios and confidence. Some euro area countries are experiencing a liquidity and confidence crisis. The close relationships between national governments and banking systems create strong feedback effects between fiscal sustainability and financial stability, aggravating the impact on financial conditions and reducing fiscal policy space. Output has weakened and growth is anticipated to remain below trend for some time as the result of the loss of confidence, tighter financial conditions and underlying retrenchment. There are large downside risks to the financial system and activity, depending on how the crisis is resolved. The capacity for additional monetary stimulus, fiscal support of demand and measures to support the banking system is much more limited than in 2008. Debt-to-GDP ratios are high in most euro area countries and market confidence in euro area sovereign debt is fragile. This limits the ability of fiscal policy to support activity and the financial system. At the same time, the effect of recent ECB measures is still unfolding and inflation expectations remain well-anchored.