Re: Volatility and the market

[Paul Davidson <pdavidson@xxxxxxx>]

At 09:38 AM 12/18/98 -0800, jod wrote:
>Paul Davidson wrote:
>>
>> Trond and David's concerns has to do with volatility in financial markets.
>> Trond's bond would not necessarily solve the problem.  There have been
>> periods when price fluctuations in bond markets clearly were much larger
>> than in equity markets-- e.g., during the early Volker years.
>>
>> The question is how to stabilize the movement of financial assets whether
>> they be stocks, bonds, foreign exchange, etc.  (What Trond and David forget
>> is that in an open economy even if you restrict the domestic price of
>> securities to plus or minus 20 %, the exchange rate permits wider
>> fluctations in the value of these stocks in terms of another currency.)
>
><<snip>>
>
>Addressing the desirable goal of reducing "irrational exuberance" in
>markets should not ignore the reality that there are occasional large
>changes in value occurring over short periods of time that simply
>reflect realistic changes in tastes and / or technological developments.

Not if markets are efficient -- for then the market would have seen the
change coming and discounted it accordingly. In an efficieht market there
can not, be definition, be irrational exhuberence.

If markets are not efficient, then a sudden change in tastes, e.g., a
sudden rush to be more liquid, can cause a catastophic collapse of
financial asset prices which can have some devestating effects on the real
economy.  Should we allow people to express this sudden "change in tastes"
instantly and without limit and merely tax a portion of the capital gain (I
assume you would not tax a capital loss ) even if this causes the death of
enterprise [and is therfore economic murder in the first degree for which
O'donnell would only have the "perp" pay a progressive fine] and others to
lose their livelihood?

>A progressive tax based on market valuations provides an impetus to
>reduce the volatility of the exuberance of bubbles by reducing the value
>itself as prices rise and reducing the loss of value as prices decline
>while at the same time collecting the society's share of the value
>created by its contribution of a viable market. I call the proposal a
>"monopoly tax" and the details are available at:

The problem with this taxation is the same as with the Tobin tax (see my
1997 EJ paper and my 1998 address to the Royal economic society).  The
basic problem is that any sort of transaction tax on financial markets
reduces volume and therefore , ceteris paribus, must increase measured
volatility -- so jod must be in error when he argues it reduces volatility.
 As I show in my lecture to the Royal Economic Society every empirical
study of transactions costs and financial markets has shown that any
increase in transactions costs SIGNIFICANTLY increases market volatility.
(For example see Jones and Seguin study in the September 1997 AER). So
jod's claim that his tax will reduce  volatility is in conflict with the
statistical facts.

Secondly such a tax has depresing effects on the real economy -- and these
effects can be severe.

finally O'donnel's tax is misnamed it has nothing necessarily to do with
monopoly per se.

Accoirdingly, I see no redeeming value in this tax proposal -- except that
it teds to have a greater incidence on the rich who are more likely to be
able to "play the market".  But what about pension funds?. Would they be
hit too?

(By the way would jod include a progressive tax on one selling one's
residence?  Now that might hit the middle class pretty hard!!)

Paul Davidson
Holly Chair of Excellence in Political Economy
Editor, JOURNAL OF POST KEYNESIAN ECONOMICS [JPKE]
Economics Department -- 523 SMC
University of Tennessee
Knoxville, Tennessee 37996-0550
email: Pdavidson@xxxxxxx;   phone: (423)974-4221;    fax: (423) 974-1686
http://econ.bus.utk.edu/Davidson.html