For example,  BIS central bankers’ speeches  7  a negative shock to a country’s income prospects will tend to raise debt sustainability concerns and hence borrowing costs, thereby worsening sustainability. Another friction is that, once internationally-held debt becomes unsustainable, restructuring it is usually a messy process because of the lack of an internationally-agreed legal framework. In part for that reason, countries have tended to delay tackling unsustainable debt. But if debt is truly unsustainable, delay tends to further worsen debt dynamics, ultimately increasing costs for both debtors and creditors (Krugman (1988)). These contractual frictions can make debt a fickle friend. They will tend to aggravate debt sustainability and debtor prevarication problems, thereby encouraging investors to withdraw credit at the first sign of trouble – so-called “sudden stops” (Calvo (1998)). These frictions are well-illustrated by historical sovereign debt restructuring experience, most recently in emerging market economies such as Argentina. Yet it is widely accepted that there are straightforward contractual solutions to these debt problems. One is to issue debt instruments whose contractual features reduce pro-cyclicality, such as GDP-linked bonds. Their repayment profile adjusts with a country’s ability to pay, thereby acting counter-cyclically and quasi-automatically to defuse repayment risk (Shiller (1993 and 2003), Barr et al (2014)). The impact of such instruments on debt dynamics could be significant. A recent Bank of England study considered the debt-to-income ratios of the G7 countries, given shocks to growth and real interest rates, comparing conventional and GDP-linked debt. The latter cut the variability of G7 debt-to-income ratios in half.
Jean-Claude Trichet: I expect that the cooperation with the UK authorities, particularly with the Bank of England, and for me personally with its governor, will be extraordinarily close. It’s a job at the level of the EU 27 where you will need a very close cooperation between Mervyn King and all of us, and I expect that this is the way we are all looking at it. 4  BIS Review 115/2010