Traffic management and financial crisis

While just walking after office for home yesterday I saw a huge traffic mess outside the historic CST railway station. This may not be new to people working in that area in Mumbai but a thought just struck me.

The place has traffic signals but because of some malfunctioning there was a problem. The outcome was everyone trying to jump signals and big confusion. As that road has fair share of traffic, one can imagine the scene.

The result was there weer traffic policemen who were trying to control the situation. However, the number of vehicles were so many that the traffic inspector was struggling to manage the situation. I believe it must have started with one traffic inspector but as situation got worse, more had to come and help the first person.

The situation is quite similar to what we see in financial markets. The traffic signals are like your various risk management techniques (VARs etc) and when things are going on well, all is ok.

However, in case of a disruption in traffic the signs are very similar to the ones in financial markets. (Note the similarity- when lights not working- someone’s risk exposures gone wrong, some vehicle having problems- some financial company having problems etc. )

And just like things become chaotic on a road in times of disruptions, similar is the scenario in financial markets.

And finally, just like when things become too chaotic, we need a traffic policeman to sort out things, similarly we need the central bankers/ policymakers to sort out problems in the financial markets.

This thought also helped me go back to a question I keep asking myself- why economists look at traffic, cars etc. to explain so many things? Answer is it just fits the entire spectrum of things in markets and economy so well.

Here is Bernanke explaining monetary policy and Jeff Frankel explaining financial globalization using very similar analogies.

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