European banks have accumulated important risks through excessive rescheduling of debt maturities, purchase of US derivatives and loans extended to companies and households of the European periphery. Aggressive lending in the – already before structurally weak – periphery countries fuelled excess demand that would have collapsed sooner or later even in the absence of a global financial market crisis. The artificial boom ended in a deep recession when over-indebtedness, together with the world-wide confidence crisis, led to a belated increase in interest rate spreads and the breakdown of financing. Economic policy, like the largely neo-classical inspired observers, underestimated the demand overshooting in the periphery countries in the run-up to the crisis, followed by far too optimistic expectations of recovery thereafter. Hence, the repeated disappointment of investors, along with the institutional lag (or even lack) of policy decisions, exacerbated and protracted the crisis. The over-reliance on fiscal retrenchment to counter the crisis is largely based on obsolete perceptions of the strength and effects of multipliers. A path of moderate consolidation, confined to the crisis countries, putting greater emphasis on temporary tax increases with smaller multiplier effects, would arguably have depressed economic activity to a lesser extent.