Financial Markets, Economic Crises And Global Co-ordination

Stiglitz wrote an interesting article in Newsweek, titled "Markets Can't Rule Themselves"***: http://www.newsweek.com/id/177447

The crux of the article is Stiglitz calling the current crisis a Bretton Woods moment. The article is a great read as it makes you pause and look carefully at the options the current administration has to solve the economic crisis. It gets you thinking about "boundary values" of the options being evaluated in the current economic scenario- a process that leads to more felicity in thinking about solutions. It certainly got me thinking- hence this post.

The Story So Far

So what has been done already toward managing risk in increasingly globalized markets? Some of you may be familiar with Basel II. Basel II (http://www.bis.org/publ/bcbs107.htm) could be called a move toward a more effective risk management approach, consistent across countries.

Where Do Stiglitz's Ideas in the Article Lead Us?

I have two impromptu thoughts on the overall direction of the ideas in the Newsweek article. Note: I am very unhappy to say I am still wrapping my head around these thoughts (read research- data and analysis).

1> Global Co-ordination Becomes One Roof to Shelter All in Implementation?

Perhaps it’s the effect of looking at Van Gogh's Starry Night, but upon reading the idea of managing monetary policy globally , I see visions of an entity called "The United Nations Central, Commercial and Retail Bank of Planet Earth". At the risk of sounding dismissive about the interesting "brainstorming ideas" in Stiglitz’s article, we know the UN has not been consistently effective in each crisis it has encountered.

Thinking through implementing an empowered global financial entity, does a parallel between Stiglitz's idea of a global financial regulatory body, and the structures that global corporations employ when dealing with a diverse portfolio of markets, which includes multiple hypercompetitive markets along with markets that resemble sleepy hamlets, make sense?

Global co-ordination has become increasingly critical for an effective response to global financial crises. However, would a light weight process or protocol that gets central banks in the same room and talking, with control and decision making remaining with central banks as they exist today, be more effective than setting up a "heavyweight" international organization?

Given our experience with the effectiveness of the SEC as a regulatory body, what can an international institution monitoring global financial crises really bring to the table?

For those who track international finance closely, how does such an international governing body impact Mundell's framework? Or should I rephrase to say how Mundell's framework would wreak havoc with any initiative of such an international governing body?

2> To Restrain Or Not to Restrain Innovation, that is the Question?

I get a feeling that Stiglitz is checking if we can put the innovation "genie back in the bottle". Unchecked innovation could be termed the root cause of the current problem and we may need to rein it in. It’s a good thought. However, the laundry list of options considered sounds like we are throwing the baby out with the bathwater.

Are we in danger of over regulating to an extent that it effectively regresses the industry? In some ways, it’s a bit like moving from the Iron Age back into the Stone Age (blame this analogy on reading a bit about Ancient Indian history connected with the Iron Age). Control on the industry is necessary via an improved regulatory framework, but how much, over what, and why?

You might argue that innovation is hardly going to be defeated by knee jerk, reactive over regulation. However, my hypothesis is that a singularity like the current economic crisis is the proverbial butterfly that causes a hurricane half way across the globe.

For those that argue that government regulation can serve as a guiding hand to financial services innovation, does a parallel between the idea of the government playing an active role in guiding financial services innovation, and the research on the impact of MITI in Japan on the Japanese High Tech industry, make sense?

3> A Global Economic Emergency?

If we were to effect some of Stiglitz's ideas- what would governments across the world need to do? Perhaps the ideas in the article need a "global economic emergency" (yes, as I write this, I am thinking- it is one of those Saturdays when the imagination runs wild) to be implementable? Any such effort entails significant, co-ordinated political will across countries and economic regions.

Is it feasible/ possible to pull off the measures like those listed in the article, for a short period of time to solve an immediate problem, and then revert to the "good old ways" with a little less laissez faire?

In Summary: Back to the Future? Guns, Germs and Steel? Alice in Wonderland? A Hundred Years of Solitude?

Playing the devil's advocate again- none my counterpoints account for the unprecedented situation we see here. I am looking at Stiglitz’s ideas, listed in the article, in the context of steady state economic policy and my counterpoints are in the same context.
Now, is the current situation really unprecendented? Are the parameters that tell us so, useful in generating an unprecedented solution?

Are we really looking to rewind time, back to a warm fuzzy place when we were still trying to figure out what the financial system could do for the economy? Is this question already too late? Could Shiva, the destroyer of worlds, the genie from the bottle, already have wiped the slate clean for us to start afresh? To gaze afresh, a bit like Alice, at the fluttering butterfly and imagine ways we could channel its untapped power and find new unintended consequences?

Show Me The Money- Is it all about The Money?

I also got thinking about an article on the Mumbai terror attacks (http://www.nytimes.com/2008/11/29/opinion/29mehta.html), where the writer signs off by saying "Stimulus doesn’t have to be just economic."

What do you think?

Thanks!

*** Posted by Prof. Rosensweig at an alumni macroeconomics message board.

P. S. Key Points of the Stiglitz Article

All ideas in Stiglitz's article, which focus on creating:
- Better monetary policy coordination across the US and Europe
- An internationally coordinated stimulus program
- Global financial regulatory body to help monitor and gauge systemic risk
- Global financial rules on managerial incentives
- A new global reserve currency
- A new system of handling cross-border bankruptcies,

arise out of this fundamental approach. This looks a lot like expanding the "The Gold standard" approach to include bailouts and bankruptcies.