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 "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 "trigger point" phenomena.
To fully comprehend these interpretations we must first understand and
differentiate between a "currency" and "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...