Financial and Real Investments: Some Notes on Tobin Tax
AbstractThere is a consensus on the demerits of volatility in short-term capital flows, which is presumably prompted by exchange rate instability. The literature lists three methods to modulate financial markets: target zone of exchange rate, dual exchange rate, and the Tobin tax. This paper argues that the rationale for Tobin tax arises from two sources: systemic, and transitory. The interest rate parity theorem links up inflation, interest rate, and the exchange rate. Hence a general equilibrium approach is warranted here. Under uncertainty, irreversible real investment has an option-value for waiting. This is a distortion caused partly by exchange rate volatility; it can be reduced by a Tobin tax. If the Tobin tax on financial investment cannot fully eliminate the distortion, a subsidy for real investment to the extent of the said option-value may be worthwhile. In this paper a model shows that a financial boom can engender a recession in output. Another model computes the option-value of postponing real investment, where interest rate has a mean-reverting geometric Brownian motion. A third model explores macroeconomic instability, and an appropriate Tobin tax. The paper emphasizes the need for stabilization of both exchange rate and interest rate.
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Bibliographic InfoArticle provided by Camera di Commercio di Genova in its journal Economia Internazionale / International Economics.
Volume (Year): 49 (1996)
Issue (Month): 1 ()
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