The Kapali Carsi

Game Theory and the Fate of the Eurozone

Thanks to the World Congress of the Game Theory Society at Bilgi University, this week Istanbul is hosting four Nobel Prize winners in Economics.

Here’s the intro. to my latest Hurriyet Daily News (HDN) column, where I refer to a recent Bank of America Merrill Lynch research report to discuss what game theory has to say for the fate of the Eurozone.You can read the whole thing at the HDN website, and there is an abridged version at this week’s Economonitor weekly.

I don’t have much to add to the column, just a few minor points:

First, I should mention that, as I have argued before, I am not an austerity fan. On the contrary, I believe it is the problem rather than the solution. But I nevertheless went ahead with the example in the paper because, as I mention in the column, it does illustrate the importance of pre-commitment.

Second, there is an important result of the research report I could not mention in the column because of space constraints. The authors argue that a weaker euro, by reducing the incentive of any country to exit, could be the Eurozone’s sole salvation. They note that a 20 percent EURUSD depreciation would restore half of Italy’s competitiveness loss against the U.S. since the inception of the common currency.  I am not sure the euro should be compared to the dollar in this kind of exercise, but still the point gets through.

Third, it is important to note that the paper is about voluntary exit; it does not analyze default. For example, according to a Spiegel article today that got emailed to me several times this morning through different sources, the IMF is tempted to pull the plug on Greece, which would lead the country to default as early as September.

Finally, the games in the report are very elementary, those you’d even see in an Introductory Microeconomics course at the undergrad. level. And Game Theory has a sort of sweet-sound to it. I can assure you it is anything but!:) And while it is quite straightforward itself, refinements to Nash  Equilibrium are not all that simple at all. For example, Reinhard Selten, who shared the Nobel with the two Johns, Nash and Harsanyi, in 1994 and one of the speakers at today’s Nobel Panel, developed such a refinement called Trembling Hand Perfect Equilibrium. Remembering on how much I struggled with that and others in grad. school really makes my hands tremble:)…

Speaking of the Nobel Panel, I couldn’t make it since I am in Marmaris, but would be interested to hear your impressions (either here as a comment, or through email) if you were there. BTW, I had a chance to listen to him once, at a seminar at MIT a decade or so ago. The movie had just come out (or was about to), so the conversation sort of flowed there. He laughingly told the audience how he thought he had been abducted by aliens, but with medication has gotten much better over the years…

BTW, I am hardly the first one to have picked up on the report. It was picked up by the media right after it was published. For example, there was a nice little Bloomberg story, for example. I read the paper after I read the articles on the web, but held on to the column to have it published on the day of the conference…

2 Responses to “Game Theory and the Fate of the Eurozone”

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