##ity shortfall or is, in fact, insolvent. bonds bought by private creditors can still be restructured at a later date, while official support can be used to smooth the economic adjustment process. of course, the financial system must also be able to withstand a debt restructuring. otherwise, precious little would have been gained. because privileged regulatory treatment allows banks to buy almost unlimited amounts of government bonds, which they are not required to back with capital, a haircut is particularly risky for banks. that has got to change. not until banks have begun to hold sufficient capital against government bonds and the size of individual exposures has been limited, will banks be able to effectively cope with the process of restructuring sovereign debt. and only then is there likely to be any concrete political will to take such action. government bonds are far from being risk - free. banking regulation should acknowledge this fact once and for all. capping the size of individual sovereign exposures in bank balance sheets would provide much of the diversification benefits that are envisaged by the european safe bond proposal the european commission has recently taken up. that proposal conceives a diversified security where member state sovereign debt is pooled and divided into a safe tranche and a junior tranche, thereby providing for risk - free assets. but a european safe bond created by an official european entity could be perceived as a stepping stone towards full - blown eurobonds, i. e. mutual liability. to avoid that perception, european safe bonds would have to be constructed by market participants. it would be easier still to split new sovereign bonds into senior and junior bonds at the time of issuance, sensibly adding a maturity extension feature for the junior bond. combined with effective regulation of sovereign bonds, this solution would offer the same advantages of diversification and safe - asset generation while being arguably much more feasible politically. these are steps that would allow the potato to be taken when it ’ s hot. but, of course, it would be better still to not let matters come to the boil in the first place. and this means strengthening sustainable growth. i ’ m convinced that we all share the view that it ’ s not central banks which can put the economy on a higher growth path. it ’ s up to governments to unlock economic growth. what ’ s needed are reforms fostering competition and innovation to make investment more profitable. with regard to europe, the finalisation of a common services market and a single digital market are promising initiatives.

the risk - reward profile of sovereign bond purchases certainly differs depending on the institutional set - up of the policy area in question. a central bank buying up federal bonds to drive down the long - term risk - free interest rate with a view to speeding up inflation is a different kettle of fish from one acting as a lender of last resort to governments. and this brings me to the issue 3 / 7 bis central bankers'speeches debated in today ’ s second panel : " who is willing to act? passing on the hot potato of policy intervention. " economists like paul de grauwe7 argue that monetary policymakers should channel their inner bagehot when it comes to sovereign debt. in his view, a sovereign that is actually solvent but suddenly falls prey to the sceptical gaze of the market can be driven into insolvency by the rising interest burden. downgraded market perceptions can amount to a self - fulfilling prophecy, a phenomenon which economists refer to as markets with multiple equilibria. in such cases a central bank should come to a country's aid, according to de grauwe. just as acting as the lender of last resort to banks serves to safeguard financial stability, so, too, could central bank intervention in the government bond market fulfil the same purpose. but for me, this stretches the analogy too far. lending to governments is different in that it is not collateralised. walter bagehot advised central banks to lend to banks only against adequate collateral, such that moral hazard is minimised. buying up sovereign bonds amounts to lending to governments without mitigating the risks of moral hazard that come with it. a second difficulty stems from the fact that it is exceedingly difficult to determine the fundamentally justified price for sovereign debt – in other words, it is all but impossible to judge whether the market reaction is justified or overblown. in determining the price by themselves, central banks are setting themselves up for pressure from governments who tend to think that they deserve better rates. it follows that the notion of central banks acting as a lender of last resort to governments is less in keeping with the bagehot tradition than is sometimes assumed. and it runs into arguably far greater problems with moral hazard, especially in a monetary union with fiscally sovereign member states, as i mentioned before. incentives to reform public finances and the real economy are stunted. if action is taken at the national level but accountability is located at the european level, chances