How can a Currency Transaction Tax Stabilize Foreign Exchange Markets?

In 1971, after the demise of the international monetary system, the so-called Bretton Woods system that ensured semi-fixed exchange rates thanks to capital controls, James Tobin conceived his now famous “Tobin tax”. Since then, some supporters of his original proposal have introduced some major changes to make it more suited to financial globalization. Paul Bernd Spahn (2002) in particular has proposed a two-tier Currency Transaction Tax (hereafter CTT). The CTT could curb the usual speculation that occurs during “normal times” but also deter big speculative attacks that strike especially, but not exclusively, developing countries. In this paper, I show that a fine tuned CTT could discourage, if not suppress, capital flights that plague fragile developing countries before and after the burst of an economic crisis. However it is true that a CTT cannot serve any purpose, but the same is true for every other proposal such as prudential regulations and capital controls. Rather than looking for the fairy’s wand, it is wiser to combine a full array of instruments at hand to construct a safe financial environment for economic progressive policies