4  Individuals might receive intrinsic utility from being thought of as high ability, or it might matter materially if future job prospects (including wages) depend on current reputation (see Scharfstein and Stein (1990)). The threat of corporate takeovers might also generate shortened managerial horizons, or agents might engage in hyperbolic discounting, which generates a short-term bias. 5  We assume no discounting, as in Rajan (1994). The qualitative results would not change were we to consider it. 6  is the probability assigned by the market of the bank being high ability, conditional on the bank setting a risky policy (unobserved by the market), the asset being bad, the macro state being and proportion other banks also setting risky policies. 4  BIS Review 168/2010  When the loan is bad, setting a tight (superscript ) policy yields  as the probability of a loss is unity under a tight policy and the bank obtains reputation . 7  The evolution of reputation is key for determining behavioural dynamics in the model. The marginal effect on reputation of banks adopting risky rather than tight policies is given by  improvements in the macro state increase the incentive banks face to We posit liberalise their risk management policies. When the macro state is good, any negative earnings are more likely to be attributed to low ability. This is the “Prince constraint”.
The Stability and Growth Pact has been strengthened to preserve fiscal stability; and a new procedure – the Macroeconomic Imbalance Procedure – has been established to prevent the accumulation of other non-fiscal imbalances. Also, the European Stability Mechanism and the banking union process have filled in two serious gaps. Now, to conclude, I shall try and respond to the questions to this panel about Germany’s role in the European debt crisis and whether Germany is a reluctant hegemon. Indeed, Germany has played a key role in the response by the European Monetary Union to its financial and fiscal crisis and to the dangers this crisis has entailed for the Union and the euro. In early 2012, many analysts and politicians considered it very possible that certain BIS central bankers’ speeches  1  countries might exit the Monetary Union, thereby triggering an extremely serious crisis. Many believed the European Monetary Union was running an almost terminal risk, at least in its formulation under the Maastricht Treaty. To Germany, then. Its economy and its Government have been fundamental in facing and overcoming these risks. Without a German political stance in defence of the Monetary Union and the euro, the single currency would surely not have survived. Obviously, Germany has not acted alone, but as the euro area’s leading economy, its role has been crucial. I do not believe Germany may be said to have exercised this role reluctantly.