Financial Instability Essay -- Financial Market Finances Accounting Es

Financial Instability The soaring volume of international finance and increased interdependence in recent decades has increased concerns about volatility and threats of a financial crisis. This has led many to investigate and analyze the origins, transmission, effects and policies aimed to impede financial instability. This paper argues that financial liberalization and speculation are the most reflective explanations for instability in financial markets and that financial instability is likely to be transmitted globally with far reaching implications on real sector performance. I conclude the paper with the argument that a global transaction tax would be the most effective policy to curb financial instability and that other proposed policies, such as target zones and the creation of a supranational institution, are either unfeasible or unattainable. INSTABILITY IN FINANCIAL MARKETS In this section I examine four interpretations of how financial instability arises. The first interpretation deals with speculation and the subsequent â€Å"bandwagoning† in financial markets. The second is a political interpretation dealing with the declining status of a hegemonic anchor of the financial system. The question of whether regulation causes or mitigates financial instability is raised by the third interpretation; while the fourth view deals with the â€Å"trigger point† phenomena. To fully comprehend these interpretations we must first understand and differentiate between a â€Å"currency† and â€Å"contagion† crisis. A currency crisis refers to a situation is which a loss of confidence in a country's currency provokes capital flight. Conversely, a contagion crisis refers to a loss of confidence in the assets denominated in a particular currency and the subsequent global transmission of this shock. One of the more paramount readings of financial instability pertains to speculation. Speculation is exhibited in a situation where a government monetary or fiscal policy (or action) leads investors to believe that the currency of that particular nation will either appreciate or depreciate in terms relative to those of other countries. Closely associated with these speculative attacks is what is coined the â€Å"bandwagon† effect. Say for example, that a country's central bank decides to undertake an expansionary monetary policy. A ne... ...onal Financial Markets,† in Gerald Epstein, Julie Graham, Jessica Nembard (eds.), Creating a New World Economy: Forces of Change and Plans of Action (Temple University Press, 1993). Charles Hakkio, â€Å"Should we Throw Sand in the Gears of Financial Markets?† Federal Reserve Bank of Kansas City Economic Review, 1994. Richard Herring and Robert Litan, Financial Regulation in the Global Economy (Brookings Institution, 1995). Ethan Kapstein, â€Å"Shockproof: The End of Financial Crisis† Foreign Affairs, January/February 1996. Charles P. Kindleberger, The World in Depression (London: Penguin 1973). Paul Krugman, â€Å"International Aspects of Financial Crises† in Martin Feldstein, ed., The Risk of Economic Crisis (Chicago: University of Chicago Press, 1991). John McCallum, â€Å"Managers and Unstable Financial Markets† Business Quarterly January 1, 1995. James Tobin, â€Å"A proposal for international monetary reform† Eastern Economic Journal 1978, volume 4. John Williamson, The Failure of World Monetary Reform 1971-1974) (NY:NYU Press, 1977) L.B. Yeager, International Monetary Relations: Theory, History, and Policy 1976. .