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13/06/2002 - Foreign currency trading is essential to the functioning of international trade and the financial system. However, there is concern that such trading can be highly volatile and disruptive, which has led to the suggestion that excessive volatility could be tempered through a small levy or "Tobin tax" on each transaction. But according to a new study by the OECD, such a tax would not necessarily reduce volatility. Its costs are also likely to outweigh potential benefits.
Such a tax on foreign exchange transactions was first suggested by the late Nobel Prize-winner James Tobin in 1971. Tobin, however, subsequently distanced himself from certain interpretations of the proposal, in particular that the levy could be used to help fund development aid to poor countries. With around 1.25 trillion dollars traded daily on the foreign exchange markets the potential revenue of such a tax is large, though not as large as some of its advocates have suggested as the tax base itself is likely to fall significantly if such a measure were introduced.
The study finds that there is a link between high volumes traded and high volatility. But it is far from clear that the former causes the latter. Volatility and trading volumes can both be triggered by the influx of information to the market, says the study.
Looking at a number of markets where transaction charges have been imposed, the study concludes that the effect on volatility is at best mixed. In some cases there was no appreciable reduction; in others, volatility actually rose, say the study's authors.
Implementation of a "Tobin tax" would be difficult. Unless it is applied on a worldwide basis, it is unlikely to be effective, the study says. The levy would also have to cover other traded financial instruments and even some real commodity markets as these could be used to avoid the tax. The consequent rise in costs could undermine potential benefits, according to the paper.
The study "Exchange market volatility and securities transaction taxes" will be published in the OECD's forthcoming Economic Outlook No. 71. Journalists who wish to receive an electronic version of the studies may contact the Media Relations Division or go to the OECD password-protected website for the press. For further information journalists may contact Stephen Di Biasio in the Media Relations Division (tel. [33] 1 45 24 81 03).
Non journalists may access the study from the OECD Online Bookshop.
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