the 1950s and 1960s, and less like they were in the 1970s and 1980s, is not that surprising. we cannot be sure, of course, whether the extent of the change has been appropriate, but we can at least see some logic for its direction. can it last? the final question, then, is whether this apparently benign state of affairs can persist. see ‘ main drivers of emerging market bond spreads : fundamentals or external factors? ’, ( box 1. 5 ), global financial stability report, international monetary fund, april 2006, pp. 28 - 31 ( available at http : / / www. imf. org / external / pubs / ft / gfsr / 2006 / 01 / index. htm ). in particular, given that long - term yields and spreads have recently been at levels seen for lengthy periods after world war ii through until the 1960s, is it possible that the prospective environment for capitalist economies is actually like it was during that period? the post - war era was a period when there were still business cycles, but there was a long - asting and pretty robust secular expansion in economic activity and global trade, with relatively little instability. granted, in europe and japan there was the rebuilding and “ catch - up ” after wartime devastation, which no longer needs to occur. but in its place is catch - up by china, india and a range of smaller economies which are engaging in the international economic and financial system. the openness of that system, if we are able to maintain it, arguably offers as much scope for strong growth accompanied by price stability as did the post - war world. or is it the case that people are underestimating the likelihood of less stable times in the future? is there, just around the corner, some event that will usher in a period of instability, triggering a wholesale reappraisal of economic and financial prospects, and hence appetite for risk? in that scenario, some of the financial exposures that were taken on in a mood of optimism over the past several years could be unwound, possibly quite disruptively. one ’ s answer to such questions hinges to a considerable extent on what one thinks was behind the enhanced stability of the past decade and a half. better macroeconomic policies, better microeconomic policies, globalisation, technological advance, good luck – all of these can plausibly be argued to have played a role. people can make their own assessments of the likelihood of a continued role for such factors

the case of uncertainty, we don ’ t or can ’ t know the parameters of the distribution. events that have no known parallel in recent history, where there is no basis for determining expected frequency or impact, will not easily be amenable to pricing. an avian flu pandemic, for example, could result in a frequency and severity of illnesses and a number of deaths that is outside any recent historical experience, with important implications for life and health insurance providers. in fact, many economic and financial processes produce outcomes that do not come from any known statistical distribution, because the human interactions which drive them are not like the turn of a roulette wheel or throw of a dice. in such a world, quantification and formal management of risk can go only so far ; there will always be some possibilities that simply can ’ t be priced. these issues are quite important, and will intrude into our discussion later on. but for now, let me turn to what the quantitative evidence can offer us. frank h. knight ( 1921 ), risk, uncertainty and profit, houghton mifflin company, boston. peter l. bernstein ( 1996 ), against the gods, john wiley & sons inc., new york. risk pricing the place to start is with the level of long - term rates on highly rated sovereign debt. given that the likelihood of default by such countries is remote, what is being priced here, essentially, is the rate and variability of future inflation. for those of us whose economics awareness dates from some time in the 1970s or later, it certainly seems that long - term interest rates globally have in recent years been unusually low. in the united states, 10 - year treasury note yields were below 5 per cent over several years, which stands out compared with the history of the preceding few decades. furthermore, it is historically unusual for these rates to have been low and pretty steady at a time when the fed is raising short - term rates. that this would coincide with a sizeable us budget deficit, and a us current account deficit of unprecedented magnitude, was certainly not anticipated by any observer i can recall. it was labelled a “ conundrum ” 3, and “ an intriguing financial phenomenon ” 4 by successive fed chairmen. long - term interest rates in other major centres – japan and europe – have been even lower than us rates. as recently as 2003, japan ’ s rates were the lowest on record anywhere that we could find over several centuries. these