Tobin Tax, Carry Trade, and the Exchange Rate Dynamics

We propose a heterogeneous agent model including the fundamentalists, chartists, and carry traders, to describe the dynamics of exchange rates, and examine the effects of Tobin Tax on the equilibrium exchange rates. A theoretical analysis shows that an increase of Tobin tax always reduces the trading volume, and its impact on the equilibrium exchange rate depends on the agents' expectations of exchange rate movements and their weights in the markets. Our simulation exercise shows that an increase in Tobin tax may lead to an increase in volatility and price distortion and a decrease in the kurtosis and the trading volume. Our results suggest that the Tobin tax could be an emergency measure, but not a long-term policy tool to suppress speculation.