If bonds are highly substitutable (as might be in the case of UST and JGB) then if Japan were to stop buying US debt instruments the effect on US rates would be minimal. PBoC cannot stop buying foreign debt instruments as it would imply very big appreciation of renminbi, it can change the currency structure of its reserve holdings. This would force a change in composition of debt in hands of private investors and the impact on US rate would be small again. •  in the scenario of rapid adjustment of US current account deficit, for example following sizeable Asian currencies appreciation, current account surpluses in EM would have to correct massively, some countries may find that their current account surpluses are smaller than debt amortizations, and history shows that in 18 percent of cases sudden stops in emerging markets took place under current account surpluses. •  Calvo view implies very low risk of US long term rates going up (high likelihood of soft landing, low likelihood of hard landing), and relatively high risk of some emerging markets experiencing sharp current account reversals and possibly sudden stops. •  Calvo view is reinforced in the recent paper by Faruqee, Laxton, Muir, Presenti (2006) 18 , which shows that even when a new wave of protectionism hits the global economy, the US growth will slow only marginally by 0.2 percent, while impact on Asia could be sizeable, reducing growth by more than 1 percent.
This pragmatic view is consistent with the idea that monetary policy decisions should be based not only on the most likely scenarios but also on other, less probable ones which, however, may have far-reaching implications  2  BIS Review 53/2006  for the entire system should they materialise. Certainly, an abrupt asset price correction pertains to this class of low-probability event that may ultimately entail significant costs for a country’s welfare. More importantly, to place this approach to monetary policy in its right place, it is critical to recognise that some of the risks inherent in the financial sphere should first be the subject of an appropriate prudential framework. It is no exaggeration to say that any concern about unbalanced market developments is, at core, a concern about a problem of inappropriate risk management. This statement applies to the case in which, due to over-optimism or short-sighted behaviour, market participants fail to appreciate the true risk of their investment or lending strategies. Yet even if their behaviour can be thought as being fully rational from an individual perspective, nothing ensures that the final outcome will not convey important risks at a systemic level that are not properly internalised by single agents. As a result, a portion of the marked volatility and procyclicality of some key financial variables, like asset prices and credit, may be understood as a reflection of individual and collective risk misjudgement.