If, however, volatility levels across asset markets abate – indicating that the financial repair process is continuing – the economic recovery should continue apace. Businesses and consumers would then be better positioned to convert the recovery into a more durable expansion.
Take the regulatory treatment of government bonds as an example. Unlike for all other forms of credit, banks do not have to hold capital against government bonds in line with the risks that they carry, and this inconsistency has dangerous side-effects. Since the euro-area sovereign debt crisis – if not before – it has become clear that government bonds are anything but risk-free.