There may be several explanations for this, for instance, that investors have confidence that the United Kingdom will manage to consolidate its budget successfully. But I believe that it is mainly because the euro area countries lack the defence mechanism that the United Kingdom has.8 The reasoning is as follows: When investors in, for instance, Italian government bonds are concerned over Italy’s creditworthiness they sell their bonds and buy something else, such as German government bonds. Then the Italian bond yields rise at the same time as liquidity leaves the country. Other investors become worried that the yields will rise further – which is the same as the value of their bonds falling – and therefore sell their holdings, which means that yields continue to rise. This becomes a spiral of falling liquidity and rising yields, which is difficult to stop. The Italian central bank is unable to do very much, as it cannot create liquidity in euro. Only the European Central Bank, ECB, in Frankfurt can do this. The Italians can ask for help, but they cannot do very much themselves – at least not in the short term. And the investors are aware of this, of course. 8  See, for instance, De Grauwe, P., “The Governance of a Fragile Eurozone”, CEPS Working Document No. 346, May 2011.
Of course, the financial crisis was due to many factors acting together. But one of the most important lessons was that one should beware of allowing debts to grow too much. This applies equally to households, companies and governments. This is neither a particularly surprising nor especially new lesson; over several hundred years, financial crises have often been preceded by periods when the attitude to credit granting and lending has been too carefree. But it seems as though this is a lesson that we must experience again and again – at least once a generation, and perhaps even more often. BIS central bankers’ speeches  1  A rapid and substantial credit expansion can cause many different problems. If the expansion is characterised by an exaggerated optimism and an underestimation and underpricing of risk, large loan losses may arise in the banks when the sentiment changes. This can lead to banks failing and ultimately to a financial crisis. We experienced this in the 1990s, and Spain and Ireland are experiencing it now. Once the economy has entered a recession after a period of rapidly-increasing indebtedness and rising asset prices, the recovery from this level may be very slow. The reason is that the economy then often enters what is known as a balance sheet recession.1 Put briefly, what this means is that the economic agents need time to adjust their balance sheets if, for example, property prices have fallen. Their incomes will for some time to come be used for amortisation rather than consumption and investment.