Financial Instability

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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 destabilization of the gold standard can be attributed to the extreme domestic economic and financial pressures brought on nation states by World War I, and not solely on the industrial and economic demise of Britain. A valid explanation for the origins of financial instability are the speculative attacks brought on by investors. Although similar in function to trigger points, these speculative cycles cannot be mitigated simply by pure recognition. Rather than acting on the value of the currency itself, speculators act on occurrences or policies that will alter the value of the currency. Instability arises from the fact that these speculative cycles induce capital flight and therefore a change in the value of that particular currency, whether or not the decisions of these investors are based on market " fundamentals." Futures, options, swaps and other financial instruments "have given investors and speculators an unheard of capacity to leverage financial markets. The greater the leverage, the greater the instability" (McCallum, 1995:12). If we examine the deregulatory process closely, it becomes clear that there is a perverse relationship between deregulation and financial stability. Say for example, investors suffer from a profit squeeze. This causes the investors to lobby politicians for deregulation. The resulting wave of deregulation fosters instability and wide swings in exchange rates which in turn cause loan defaults and
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