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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 speculationare the most reflective explanations for instability in financial markets andthat financial instability is likely to be transmitted globally with farreaching implications on real sector performance I conclude the paper with theargument that a global transaction tax would be the most effective policy tocurb financial instability and that other proposed policies such as targetzones and the creation of a supranational institution are either unfeasible or unattainableINSTABILITY IN FINANCIAL MARKETS In this section I examine four interpretations of how financialinstability arises The first interpretation deals with speculation and thesubsequent bandwagoning in financial markets The second is a politicalinterpretation dealing with the declining status of a hegemonic anchor of thefinancial system The question of whether regulation causes or mitigatesfinancial instability is raised by the third interpretation while the fourthview deals with the trigger point phenomena To fully comprehend these interpretations we must first understand anddifferentiate between a currency and contagion crisis A currency crisisrefers to a situation is which a loss of confidence in a countrys currencyprovokes capital flight Conversely a contagion crisis refers to a loss ofconfidence in the assets denominated in a particular currency and the subsequentglobal transmission of this shock One of the more paramount readings of financial instability pertains tospeculation Speculation is exhibited in a situation where a governmentmonetary or fiscal policy or action leads investors to believe that thecurrency of that particular nation will either appreciate or depreciate in termsrelative to those of other countries Closely associated with these speculativeattacks is what is coined the bandwagon effect Say for example that acountrys central bank decides to undertake an expansionary monetary policy Aneoclassical interpretation tells us that this will lower the domestic
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