FXE: A bad answer to good questions

Abstract

Of these three targets, the third is at the forefront of international discussions today. One solution widely discussed are the so-called Tobin tax proposals. Of the two substantive proposals, the first aims at reducing the volatility of financial markets by imposing a worldwide transactions tax. The second seeks to protect the current process of monetary unification in Europe by imposing a tax on domestic currency loans to non-residents by European banks in order to increase the cost of speculation when such loans are made (Eichengreen et al., 1995). This kind of solution is rejected, rightly in my view, by Ruben Mendez, and one could add other criticisms to those he suggests in the article (pp. 499-513). For example, neither proposal would prevent countries from experiencing exchange rate crises. If currency traders expect the possibility of large gains, the increased transaction costs would not be a sufficient deterrent. Furthermore, they would not free monetary authorities from the need to increase interest rates in case of a speculative attack, leaving unresolved the dilemma between the domestic objective of securing growth and employment and the external objective of retaining exchange rate stability. In spite of being presented as an alternative solution, FXE tells us nothing about how it could help to avoid unjustified, but self-fulfilling,