The cutting of interest rates by six central banks across the world was perhaps the first coordinated response to the global financial crisis. It took the affected nations, mostly advanced industrial countries, 10 days to begin cooperation. What took them so long?
On Wednesday, six central banks — the US Federal Reserve, the European Central Bank and those of the UK, Canada, Sweden and Switzerland — cut interest rates by 0.5%. The step did not calm jittery financial markets. Increasingly, the imagery behind frozen credit markets is that of a financial Stone Age. After exotic securities bombed out, we may be back to plain vanilla financial stuff.
Illustration: Jayachandran Nanu / Mint
The imagery, the crisis and the behaviour of the players is reminiscent of what the medieval European thinker, Jean Jacques Rousseau, had to say about cooperation in such circumstances. In his book, A Discourse on Inequality, he analysed what game theorists call the Stag Hunt game. A number of hunters can cooperate and hunt a stag. This requires that they all stick to their positions in the forest while hunting the stag. Otherwise the stag can’t be bagged. The forest is stocked with hare as well. But if a single hunter is tempted to chase a hare, the game’s up. The question is, under what circumstances do players go stag-hunting? When do they hunt hare?
These questions emerged in Europe in the last 10 days. A day after the US Congress rejected the $700 billion bailout plan on 29 September, Ireland’s government guaranteed the deposits and borrowings of six banks in that country. There was dismay and consternation. Within days a host of Europeans countries followed suit, hunting hare. Yet, what was called for was a united plan of action, something akin to hunting a stag.
There may be no option but to cooperate. If there’s a global financial meltdown, there may be no national markets left to protect. That seems to have dawned on these countries, a bit late though.
It has been argued that under the circumstances, the International Monetary Fund (IMF) may have a very useful coordinating role to play. If countries can’t agree, a single multilateral agency might be able to do the job. Unfortunately, IMF’s poor performance during the Asian financial crisis of 1997 has weakened its credibility. Also, because the current crisis involves poorly regulated entities such as investment banks and hedge funds, IMF may not have the tools to tackle the problem root and branch. There simply is no alternative to international cooperation. Time nations stopped hunting hare.
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