Improving Financial Markets

Most of the discussion in recent years has focused on whether or not these flows are too large and too volatile. This focus has taken the discussion towards considering whether capital controls or transactions taxes1 might be the best method for reducing the volume of flows or velocity of trading and thus reducing the volatility of flows. This paper is designed to broaden that discussion by introducing the consideration of a set of prudential regulations for financial markets. Prudential regulation can accomplish the same ultimate goals as capital controls and transactions taxes while also claiming to improve market efficiency (lower costs of capital to developing economies) and reduce developing country exposure to other financial risks. Moreover, these regulatory proposals could be adopted unilaterally, thus allowing greater national policy autonomy. They would not have to wait upon a widespread agreement on a global tax.

The paper is organized in the following manner. Section II describes a set of regulatory proposals and discusses their policy impact. The section after that compares the above regulatory proposal to that of capital controls, and the section after that compares the regulatory proposal to a transaction tax approach. The paper concludes with a brief summary.