euro area governments if certain institutional prerequisites are met. first, borrowers must adequately and promptly respond to market signals. second, transparent and timely information concerning the actions and the budgetary position of sovereign lenders should be available to all agents ( and a reform designed to improve the quality and reliability of fiscal statistics by strengthening eurostat ’ s powers has been recently adopted ). third, full bail - out of troubled governments should be credibly ruled out. a no - bail - out clause is already enshrined in the european treaties, but many investors were inclined to believe that the clause would not be applied in an emergency. this implied that, ex ante, investors did not demand sufficiently higher premia for holding government bonds with higher default risk. by contrast, if the threat of a default is credible, this will foster stricter market oversight and induce less fiscal profligacy ex ante. in equilibrium, default will be less, not more, likely. but how can a no - bail - out clause be made credible? the answer, of course, is by making, ex post, the bail - out more costly than a bail - in for official lenders ; that is, by reducing the spillover of a sovereign default so that the economic and political costs of a default fall mainly on the defaulting country. it is paramount to weaken the link between sovereign risk and bank bis central bankers ’ speeches risk. this will require a careful analysis of the many different channels through which a deterioration in fiscal conditions affects the cost and availability of bank funding. for example, regulators might want to carefully assess the ( regulatory ) incentives banks have to hold excessive amounts of risky sovereign bonds, and the collateral rules that are used by central banks and in wholesale markets could be reconsidered. the link between sovereign and bank credit ratings should also be carefully examined. rules and markets should not be seen as mutually exclusive, but as mechanisms that complement and reinforce each other. the challenge would be not only to limit the intermediary ’ s exposure to a given sovereign borrower considered in isolation, but also to guarantee that intermediaries can survive even if debt restructuring in one country triggers restructuring in others. it should also be taken into account that a default can threaten financial stability through its impact on derivative markets ( e. g. the market for credit default swaps ). all this clearly requires regular stress testing of financial intermediaries and the availability of timely and objective assessments of

high social or political costs, which are even less straightforward to judge and to measure. still, this issue cannot be avoided. we need to think about what institution should be in charge of such evaluations, and acknowledge that it should comprehensively consider the evidence and assessments provided by credit rating agencies, national fiscal councils, international financial institutions and organizations. a tough assignment, indeed. to conclude, i have to confess that, in a sense, i have cheated you. my einaudi ’ s quotation was actually incomplete. he not only said that “ investors have the heart of a rabbit, the legs of a hare … ” ; he continued and said that they have “ … la memoria di un elefante ” ( “ the memory of an elephant ” ). this should be a reminder of the disruptive consequences of a default, which often permanently stains a government ’ s reputation. governments that default are excluded for potentially long periods from international capital markets, especially when bis central bankers ’ speeches markets consider the default opportunistic. they also face an increased cost of borrowing thereafter. finally, and perhaps most importantly, default also signals an overall lack of reliability of the country. a proper design of the conditions for the ex - ante involvement of creditors in an orderly restructuring of the debt of a sovereign borrower and the definition of appropriate incentives for a more gradual, timely and responsible market assessment would significantly reduce the probability of sovereign default and the risk of extremely harmful financial stress associated with such an event. bis central bankers ’ speeches