Coping with, and cashing in on, international capital volatility

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Journal of International Development J. Int. Dev. 13, 1±24 2001) DOI: 10.1002/jid.718 COPING WITH, AND CASHING IN ON, INTERNATIONAL CAPITAL VOLATILITY GRAHAM BIRD 1 * and RAMKISHEN S. RAJAN 2,3 1 Surrey Centre for International Economic Studies, University of Surrey, Guildford, UK 2 School of Economics, University of Adelaide, Australia 3 Institute of Southeast Asian Studies ISEAS), Singapore Abstract: The political economy of currency taxation suggests that the idea will receive more support if it can be shown to make a signi®cant contribution to offsetting the perceived inef®ciencies of private international capital markets. This paper explores what can be expected from a currency tax in this respect. It shows that there are simple but neglected analytical issues that make such a tax an attractive idea. If the tax is relatively ineffective in helping to avoid ®nancial crises and calming markets, it will be relatively effective at providing the resources necessary to mitigate the aftermath of such events. The paper offers new proposals for using the revenue from currency taxation to ®nance the operations of the IMF. Copyright # 2001 John Wiley & Sons, Ltd. 1 INTRODUCTION The volatility of international capital ¯ows and the incidence of international ®nancial crises have led to calls for the existing international ®nancial architecture to be reformed. But how? One idea that has been around since the 1970s is that a tax should be levied on international currency transactions. Would such a tax reduce capital volatility and help avoid currency crises, or would it prove ineffective and infeasible? The political economy of currency taxation suggests that the idea will receive more support if it can be shown to make a signi®cant contribution to offsetting the perceived inef®ciencies of private international capital markets. This paper explores what can be expected from a currency tax in this respect. It shows that there are simple but neglected analytical issues that make such a tax an attractive idea. If the tax is relatively ineffective in helping to avoid ®nancial crises and calming markets, it will be relatively effective at providing the resources necessary to Copyright # 2001 John Wiley & Sons, Ltd. Correspondence to: Graham Bird, Surrey Centre for International Economic Studies, University of Surrey, Guildford, UK. E-mail: [email protected]

Transcript of Coping with, and cashing in on, international capital volatility

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