reforms or macroeconomic adjustments that could help a country to regain solvency are not adopted, this is not for lack of possibilities but because they are deemed undesirable – the sovereign debtor prefers not to take on all the burden of the required adjustment – or socially and politically unfeasible – the government may not be able to pass and enforce the consolidation package. indeed, governments are different from firms. while the latter are forced to go bankrupt when they do not have enough resources to repay their creditors, governments may choose to default on their obligations even though, in principle, they could always find ways to honour their debt by cutting expenditures and / or increasing revenues. concerning the desirability of a default, however, as the imf has recently pointed out 1, a default is not an easy substitute for a painful fiscal adjustment. in fact, when the starting position of the defaulting country is a primary fiscal deficit, a marked move into a primary surplus is also required, as the country usually has no longer access to borrowing in the aftermath of a default. this would indeed be the case for many advanced economies today, for which the interest bill is not the main component of the deficit. i agree with balcerowicz that the standard approach, treating the debt - distressed sovereign as a benevolent social planner maximizing social welfare in an infinite time horizon, is not cottarelli, forni, gottschalk and mauro ( 2010 ). appropriate. different strategies to cope with a high - debt situation entail different redistributive consequences and social groups have often conflicting economic interests with respect to the policy to pursue in the midst of a debt crisis. the choice made by governments to cope with high public debts may therefore be better explained from a political economy perspective : the specific interests and relative political strength of different constituencies may definitely matter in such a choice. this approach can also help to explain the historically observed phenomenon that some countries are more likely to default than others ; 2 to cite just one example, argentina has defaulted three times since 1980. moreover, most debt repudiation episodes in these defaultprone countries happened at what we would today consider relatively low levels of debt. at the end of 2001, for instance, when argentina defaulted on the larger part of its public debt, the debt - to - gdp ratio was slightly above 50 per cent ( though already 15 percentage points higher than three years earlier and 90 percentage points below its nominal value one year later, after

there is no shortage of ideas around for how the capital regime might be modified to dampen potential pro - cyclicality. some have suggested that a regime that adjusts regulatory minima with the cycle could help reinforce the message that buffers need to be built up in good times and are there to be used when a rainy day arrives. to a degree, this is already possible under the second pillar of basel ii. however, too much divergence in national implementation of pillar 2 would raise issues of transparency and consistency in international regulatory arrangements and should therefore be constrained. to be credible, a discretionary system would need to be limited in its scope, fully transparent, and broadly consistent across countries ; ad hoc, uncoordinated reductions in required minima could be viewed as forbearance and could give the wrong signal about authorities ’ judgement as to the overall strength of the system. it may also be possible to give more attention to the mix of capital instruments supporting banks ’ risk exposures. there may be scope to enhance the quality of capital during strong economic conditions. a complementary policy aimed at strengthening buffers could look at mechanisms to automatically increase bank equity levels in bad times, such as reverse convertible debentures proposed by flannery or the insurance scheme proposed by kashyap, rajan and stein. although many issues of security design would need to be addressed for these instruments to effectively discipline banks, generate adequate investor demand, and to be reliably collected on when bad states occur, these mechanisms could potentially reduce the bad - signal problems associated both with discretionary changes in minima and with capital - raising efforts by the banks themselves. a necessary complement would be a disclosure framework for risk exposures and valuations that prevents the market taking conversion events or the resort to insurance as a trigger for a broader downgrade of the system ’ s future prospects. strengthened capital and liquidity buffers and improved incentives to assess and manage risk should all help reduce the pro - cyclicality of the financial system, and, in the new configuration of the financial services industry more than ever, help monetary policy to attain its traditional objectives. but should monetary policy itself embody in its objective function the health of the financial system? as chairman bernanke and others have noted, we cannot afford to ignore the health of financial markets when setting monetary policy. it would be difficult to disagree with this statement, and we should try to make it operational considering however that its application may have different degrees of intensity.