Efficiency and fragile speculative financial markets: against the Tobin tax and for a creditable market maker - Special Invited Issue: Money, Trust, Speculation and Social Justice - Part 3: Trust and Speculation

American Journal of Economics and Sociology, The, Oct, 1998 by Paul Davidson

Whether the market is dominated by amateurs or even professionals who are rewarded based on their short-term quarter-to-quarter or even day-today performance results, then any apparently ephemeral event can unleash the music for what I call bandwagon behavior - and as a result such bandwagon behavior can be legitimate and self-justifying.

II

Conventional Policies and Market Instability

Many Old Keynesians, New Keynesians, and even some Post-Keynesians have been associated with the extreme view that because the future is uncertain, the financial system is inevitably and inherently fragile. For these scholars it is the inevitable financial fragility of markets that is the sole (primary?) cause of real economic instability. For many Old Keynesians and some Post-Keynesians, financial markets are the fundamental source of destabilizing forces that create "real economic consequences that are devastating for particular sectors and whole economies" (Eichengreen, Tobin, and Wyplosz, 1995, p. 164). Accordingly, many of these Keynesian scholars have recommended public policies that constrain or restrict free trading in financial markets. Old and New Classical economists, on the other hand, believe in the absolute robust efficiency of free financial markets where speculation is inherently stabilizing. They are unanimously against any restrictions on free financial flows into and out of financial markets.

Today's conventional wisdom of New Democrats-New Liberal political leaders and their sycophant New Keynesian economists attempts to occupy some middle ground. They recognize that the late twentieth century freemarket capitalism has not quite yet attained the state of perfection claimed by their New Classical brethren. The New Keynesian conventional wisdom is that there is a role for a small army of skilled technicians (primarily enlisted from their former graduate students) who would keep the free market machine from being pushed off of its tracks by scoundrels, wastrels, shirkers, and fools. New Keynesians do not ascribe financial market instability, especially in foreign nations, to the existence of a a truly uncertain future, which makes reliable estimates of future quasirents "fundamentals" impossible. Rather New Keynesians associate financial market instability with the actions of dishonest government employees, capitalist cronyism, fool investors, etc who flourish in a world of asymmetric information. Accordingly, public policy merely requires dissemination of existing information.

For example, in a May 1998, Levy Institute Report (p. 3) on a conference in honor of Hy Minsky on the "fragility of the international financial system," Federal Reserve Vice-Chair Alice Rivlin is reported as offering "two key prescriptions, one relating to transparency" and the other "increased supervision and monitoring of emerging financial markets." Rivlin's key proposals imply that international financial markets problems are entirely due to the "other guy," and that transparency and Central Bank regulation in the developed world's financial markets do not require any major policy fix. The Federal Reserve (and the Bank of England and the Bundesbank - but apparently not the Bank of Japan), one supposes, have the situation well in hand.