But what is important is to realise that the deficit generated over these two years has a significant structural component, given that current primary public spending has maintained a high growth rate and the sizeable extraordinary revenue linked to the real estate sector has been lost for good. The deterioration in the fiscal position is manifest in a strong increase in public debt. As our own experience shows, the dynamic of rising indebtedness can prove difficult to break, especially when it is inconceivable that we can count in the future on some of the factors that significantly helped reduce debt in the past, such as interest-rate cuts and high economic growth over a very lengthy period. Overall, all these factors increase the risk that, in the absence of corrective measures, the fiscal position will continue to worsen. Further, they lead to the conclusion that the room for budgetary policy to expand has been completely exhausted, and that it is vital that a credible strategy of budgetary consolidation be adopted for the medium term. If not, the increase in public debt and its influence on the net borrowing costs of our economy, and even on the very soundness of the financial system and its capacity to properly channel resources, may become a very heavy weight holding back our possibilities of recovery. Given the fiscal imbalance that has built up, the scale of adjustment needed is most sizeable and will therefore require the adoption of highly ambitious measures on all budgetary fronts.
This has led to the built-up of imbalances which increase the risk of a substantial price corrections and of loan losses (charts 13 and 14).6 A second, related, danger is that low rates may induce excessive risk-taking in financial markets – as opposed to reviving productive risk-taking, which is one of the objectives of low policy rates. Here, the economic literature stresses two channels: investors who are unable or unwilling to accept low returns are liable to take higher risks and increase leverage to reach their return objective, a phenomenon known as “search for yield” (chart 15).7 In addition, by pushing up asset prices and dampening price volatility, low interest rates reduce  5  This view is also reflected in market expectations. For instance, 10 year inflation expectations for the US, derived from the yield differential of inflation-linked government bonds and nominal government bonds, stood slightly below 2.25% in August 2013. 6  Empirical evidence suggest that a simultaneous built-up of imbalances in real estate and credit markets is a key leading indicator of subsequent financial instability. Cf., for instance, Schularick and Taylor (2012) and Borio (2012). 7  Cf. Borio and Zhu (2008) and Gambacorta (2009). 4  BIS central bankers’ speeches  measured risk and may lead investors to misjudge the true risk of a given investment.8 A long period of low rates, for example, may lead borrowers and lenders to overestimate debt affordability and underestimate the risk of higher debt servicing costs in the future.