Tobin Tax Effects Seen from the Foreign Exchange Market's Microstructure

There are strong calls for the introduction of a "Tobin tax" on foreign exchange (FX) transactions. Despite its popularity, research has not yet made full use of available insights from the recent microstructure literature. The role of banks in FX trading is quite different from the assumptions of proponents. Asset managers are most probably the group with the heaviest influence on shorter-term exchange rate movements. They speculate under comparatively longer horizons than FX dealers, although their behaviour also tends to be short-termist. We argue that there is no tax rate that could both influence their behaviour and simultaneously maintain the desired high level of liquidity. We conclude that no uniform proportional Tobin tax can achieve its objectives. Copyright 2003 by Blackwell Publishers Ltd.