First, when the sovereign debt crisis intensified, haircuts on government bonds under stress also went up because the rise in yields reduced their collateral value. For example, when the spread on Italian ten-year government bonds relative to core issuers rose to over 450 basis points in November 2011, the haircut for Italian government bonds was increased by 500 basis points, leading to a posting of intraday margins about 12 times greater than in any other preceding month in 2011. On the day of the increased haircut alone, the spread between Italian and German government bonds rose by 60 basis points. In addition, margin increases generally reduce the amount that a repo seller can borrow, which might increase the seller’s probability of default. This can trigger a negative feedback loop: increases in the probability of default might cause repo buyers to increase the haircuts imposed on the seller, which reduces the amount the seller can borrow (when it needs to borrow subsequently), and so on. 10 The ECB/Eurosystem has been successful in easing market tensions using standard and non-standard tools. However, the underlying structural problems which relate to uncertainty about risk, whether in the form of counterparty, credit, liquidity or redenomination risk, need to be solved. When implemented, the Single Supervisory Mechanism will play a key role in comforting confidence in euro area banks and re-establishing cross-border liquidity flows within the region. Market re-integration has now started. It will succeed only if it is supported by continued efforts by governments to bridge fiscal and competitiveness imbalances.
To sum up, the economic analysis indicates that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. A cross-check with the signals from the monetary analysis confirms this picture. As regards fiscal policies, the Governing Council welcomes the European Commission’s assessment of the 2014 draft budgetary plans which were submitted in October for the first time under the “two-pack” regulations. This new surveillance exercise needs to be fully effective. In order to put high public debt ratios on a downward path, governments should not unravel their efforts to reduce deficits and sustain fiscal adjustment over the medium term. In  2  BIS central bankers’ speeches  particular, consolidation measures should be growth-friendly and have a medium-term perspective, so as both to improve public services and minimise the distortionary effects of taxation. At the same time, there is a need to push ahead with product and labour market reforms, in order to improve competitiveness, raise potential growth, generate employment opportunities and foster the adaptability of our economies. We are now at your disposal for questions. BIS central bankers’ speeches  3