Wednesday, December 2, 2009

Krugman's Tobin Tax: Shooting the Messenger

Stefan Karlsson wrote a post clearly explaining one of the main problems (although not the only one) with Krugman's defense of the Tobin tax. In his words:

... The transactions that would be particularly discouraged by a Tobin tax would be arbitrage type dealings trying to close discrepancies in pricing. Ending arbitrage trade would represent a big reduction economic efficiency.

And furthermore, by reducing trading volumes, slippage (the decrease/increase in price caused by an individual actor's sale/purchase, something which prevents the realization of potential gains through transactions) would increase, something which would produce non-trivial costs for people engaged in foreign trade and long-term investments.

Thus, problems with large exchange rate fluctuations are not the result of “speculation”, but are inherent in the nature of fluctuating currency exchange rates. Given that system however, short-term speculation is a force that reduces, and not aggravates the problem. This applies to short-term speculation in other markets too.

In other words, Krugman's financial transactions tax economics is based on the wrong notion that, to solve a problem, all that you need to do is to shoot the messenger.

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