Financial Instability Essay

3611 Words Oct 2nd, 1999 15 Pages
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
…show more content…
The neoclassical interpretation asserts that regulation is thought to create incentives for risk taking and hence instability. It is said to bring about what are called "moral hazards." Proponents of deregulation argue that when people are insured, they are more apt to take greater risks with their investments in financial markets. The riskier the investment activity, the more volatile the markets tend to be. A closer look suggests that perhaps only two of these explanations are valid when thinking about the origins of financial instability. The trigger point explanation seems to be a misreading of the origins of instability. It is unlikely that a large number of investors would have the incentive or operational ability in order to simultaneously coordinate the buying or selling of a currency or assets denominated in that currency. If even there is such unlikely coordination, the "existence of even a very large group of investors with trigger points need not create a crisis if other investors know they are there" (Krugman, 1991:96). The theory of hegemonic stability also overlooks a number of factors that can provide useful insights in explaining the emergence of financial instability. Historical precedence supports this assertion. For instance,
Britains role as international economic manager was very minor in the stability experienced under the gold standard. The success of the standard can be

Related Documents