Coordination and market failure

During crisis there is needed a clear consensus on what action should be taken to calm markets that now have a herd mentality. Consensus is need to to provide the heft to match the negative psychology that is occurring. Without coordination there will also be economic tension across countries which will affect capital flows. You cannot have some countries providing full deposit insurance and other not when all are suffering from the same problem. Why take an action to lend if the expectation is that you may get a better deal somewhere else? Of course, in periods of very high uncertainty there is just a plain flight to quality and in this case it is to the yen and dollar.

Coordination is also required because of the high correlation across markets. There is clear contagion to all parts of the globe so any action in one country will spillover to others.

Policy coordination can come from two sources. First, we will have the G7 meeting which will allow large economies to speak with one voice and provide joint support. However, the one voice should include the BRIC economies. They have a huge stake in the success of any plan and their help is warranted and needed. Second, there needs to be a clear statement of action from the IMF and World Bank.

In the case of the IMF, there is a mandate to provide liquidity and coordination across countries when there is a liquidity crisis. Specifically, they should provide support for the world banking system to ease any credit tensions. The World Bank has been looking for a new mission since the ascent of many emerging markets. This is the time and place for help. A calmer world financial market is necessary for overall global growth especially for those countries in poverty.