premium when public debt is rolled over. real refinancing costs of governments could become even higher once the genie of higher inflation rates was out of the bottle. 4. it is a myth that accelerated inflation can be a substitute for economic adjustment. remember that the necessary disinflation policies of the late 1970 and early 1980 came along with high costs including severe recessions and sharp increases in unemployment. the case of the euro area although elevated debt levels are a common feature of advanced economies the euro area has been at the epicentre of the current public debt crisis since spring 2010. strangely enough, on a consolidated base public finances in the euro are in a more favourable position than for example in the us. the euro area as a whole will run a budget deficit of about 4. 5 % of gdp this year. the international monetary fund ( imf ) expects a us budget shortfall of about 10 percent of gdp this year. according to the commission ’ s spring forecast, the euro area deficit ratio is projected to decline to 3. 5 % of gdp by 2012. by comparison, in the us and japan fiscal deficits are expected to be at 8. 6 % and 9. 8 %, respectively, in 2012. on the other side of the channel, the uk expects for this fiscal year to meet its deficit target of 7. 9 % of gdp, down from 9. 3 % of gdp in the previous one ending in april 2011. the budget forecasts however are based on the assumption that the economy will grow 1. 7 % in 2011 – a euphemistic view compared to private sector economists ’ recent forecasts of 1. 0 to 1. 3 %. according to the imf the aggregate public debt - to - gdp for the euro area stands at 87 percent. figures for the uk are similar. for the us the debt - to - gdp ratio in 2011 is expected to be 100 percent. in japan public debt - to - gdp exceeds 200 percent. under market scrutiny still, it is the euro area that is under particular market scrutiny. market judgement can sometimes deviate from economic fundamentals. even wealthy states with sound economic fundamentals are in trouble to refinance themselves at reasonable conditions. comparing for instance britain and spain based on debts, deficits and inflation, britain should be the riskier credit. but british bonds yield around 2. 3 % while spain ’ s yield around 5. 5 %. moreover, market sentiments can deteriorate dramatically within

days – although economic fundamentals might not have changed. in mid october italian one year bonds yielded around 3. 5 %. last week they yielded around 7 %. bis central bankers ’ speeches main differences to other countries although financial markets might temporarily be irrationally pessimistic there is no room for complacency and the challenges must still be addressed. in order to do so, it seems reasonable to recall what makes the euro area different from other currency areas. the euro area is an alliance of sovereign countries without a central government or budget. most of the relevant political decisions – including public finance – are taken by national governments. in this constellation member states share a common monetary policy and lack the instrument of the nominal exchange rate to react to internal or external imbalances. in this institutional environment there has always been a risk embedded : moral hazard could arise when fiscal profligacy of one single member state can be compensated on average by the sound economic behaviour and stable public finances of the majority of the other countries. such an incentive structure is flawed in so far as it can lead to unsustainable fiscal policies of individual member states which in turn would generate negative spill over effects to the monetary union as a whole and make financial markets to paint other members states with the same brush. with hindsight, the original attempt to substitute a single government by rules, market and peer pressure has not been sufficient. although the no - bail - out clause and the stability and growth pact ( sgp ) were installed to exclude free rider incentives and to ensure the alignment of national fiscal policies, imbalances have emerged and the current crisis has not been prevented. particularly, there was a lack of political will to commit to sustained stability - oriented fiscal policy. the weak commitment was evident when the stability and growth pact was watered down under the pressure of france and germany in 2003. moreover, a crisis was not included in the scenarios to be prepared for. no crisis resolution mechanism for the euro area was foreseen. political and institutional challenges crises always must be seen as opportunities. as the swiss writer max frisch once said : “ a crisis is a productive time. it just has to be cleansed of the taint of a catastrophe. ” all advanced economies have to take swift, decisive and credible action to tackle the challenges that go along with the global debt crisis. this clearly includes the euro area. having discussed the feasible options to overcome the debt challenge and the particularities of the euro area it is