Higher solvency risk also increases other risks at the macro level, such as the risk of “financial repression”. 5 As public debt rises to unsustainable levels, domestic financial institutions may be “encouraged”, if not forced, to hold domestic sovereign debt in their portfolios. This would lead to inefficient allocation of capital, high costs of financial intermediation and thus lower growth. 6 Finally, in the case of reserve currencies, higher solvency risk would potentially hamper the stability of the international financial system. These questions are just a few examples of the issues on which we need further work. To conclude, it is clear that current and increasing levels of public debt in advanced economies raise problems which are not only of a macroeconomic nature, but affect many other dimensions of the global economy. On the other hand, our ability to understand the complexity of the issue is still limited. This situation is worrying, to the extent that our societies may take decisions on the basis of imperfect models and wrong assumptions. Not everybody agrees with the concerns I have just raised, and many take the current very low yields on some government bonds as a comforting sign. My impression is that they may be confusing relative and absolute concepts of risk. And such a mistake could entail very high costs for our societies. Thank you for your attention. 2  Reinhart, C. and K. Rogoff, 2010, “From Financial Crash to Debt Crisis”, NBER Working Paper 15795.
It ultimately depends on the country’s ability to raise taxes and sustain a level of primary  BIS Review 126/2010  3  surplus that enables the debt to be stabilised and reduced over time. This depends both on economic and political factors that are not easy to summarise in the nice differential equations that economists like to work with. It is thus inevitable that simplifying assumptions are made, but it is often forgotten that excess simplicity may lead to partial or even wrong results. Let me briefly elaborate. The analysis of the sustainability of sovereign debt has largely been based on the experience of developing or emerging market countries. It is now applied to advanced economies, starting with Greece. How often do we hear that Europe should learn from the Brady bond experience to address the Greek debt problem? We should, however, examine the risks associated with reasoning by analogy in this way. The risk is that solutions devised for a particular case are not applicable to other cases. Let me give you some examples. First, in many debt crises of the past in emerging market economies, the fiscal problem was not necessarily the main cause of the crisis. More usually, the crisis originated in the combination of an unsustainable exchange rate peg and foreign denominated debt.