Financial Instability The surge in the volume of international finance and increased interdependence in recent decades has increased concerns about volatility and threats of a financial crisis. This has led many to investigate and analyze the origins, transmission, effects, and policies aimed at preventing financial instability. This article argues that financial liberalization and speculation are the most significant explanations for financial market instability and that financial instability is likely to be transmitted globally with far-reaching implications on real sector performance. I conclude the paper by arguing that a global transaction tax would be the most effective policy to curb financial instability and that other proposed policies, such as target zones and the creation of a supranational institution, are infeasible or unattainable. INSTABILITY IN FINANCIAL MARKETS In this section I examine four interpretations of how financial instability arises. The first interpretation concerns speculation and the resulting "bandwagon" in the financial markets. The second is a political interpretation that has to do with the declining hegemonic anchor status of the financial system. The question of whether regulation causes or mitigates financial instability is raised by the third interpretation; while the fourth vision deals with the phenomena of “trigger points”. To fully understand these interpretations we must first understand and distinguish between “currency” crises and “contagion” crises. A currency crisis refers to a situation in which loss of confidence in a country's currency causes capital flight. In contrast, a contagion crisis refers to a loss of confidence in assets denominated in a particular currency and the subsequent global transmission of this shock. One of the most important readings of financial instability concerns speculation. Speculation occurs in a situation where a government's monetary or fiscal policy (or action) leads investors to believe that that particular nation's currency will appreciate or depreciate in terms relative to that of other countries. Closely associated with these speculative attacks is what is called the “bandwagon” effect. Suppose, for example, that a country's central bank decides to undertake an expansionary monetary policy. Ane... half of the paper... financial capital markets", in Gerald Epstein, Julie Graham, Jessica Nembard (eds.), Creating a New World Economy: Forces of Change and Plans of Action (TempleUniversityPress, 1993). Charles Hakkio , “Should we throw sand into the gears of financial markets?” Federal Reserve Bank of Kansas City Economic Review, 1994. Richard Herring and Robert Litan, Financial Regulator in the Global Economy (Brookings Institution, 1995). Ethan Kapstein, “ Shockproof: The End of Financial Crisis” Foreign Affairs, January/February 1996. Charles P. Kindleberger, The World in Depression (London: Penguin 1973) Paul Krugman, “International Aspects of Financial Crises” in Martin Feldstein, ed., TheRisk of Economic Crisis (). Chicago: University of Chicago Press, 1991. John McCallum, “Managers and Unstable Financial Markets,” Business Quarterly, January 1, 1995. James Tobin, “A Proposal for International Monetary Reform,” Eastern Economic Journal 1978, volume 4. The Failure of World Monetary Reform 1971-1974) (NY:NYU Press,1977)LB Yeager, International Monetary Relations: Theory, History and Politics 1976..