Download Obstfeld Working Paper No. 1692

NBER WORKING PAPER SERIES
CAPITAL MOBILITY IN THE WORLD
ECONOMY: THEORY AND MEASUREMENT
Maurice
Obstfeld
Working Paper No. 1692
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
August 1985
The research reported here is part of the NBER's research program
in International Studies and project in Productivity and Industrial
Change in the World Economy. Any opinions expressed are those of
the author and not those of the National Bureau of Economic
Research.
NBER Working Paper #1692
August 1985
Capital Mobility in the World
Economy: Theory and Measurement
ABSTRACT
This paper is a critical assessment of some recent empirical
evidence on the
extent
of international capital mobility. Its major
conclusion is that while much of this evidence is difficult to
interpret without ambiguity, it is consistent with a world economy
in which the degree of capital mobility is high and increasing.
Two main approaches to the measurement of capita]. mobility are
discussed. The first, traditional, approach is based on comparing
expected yields on assets located in different countries. The
second,
and more novel, approach is based on comparing national
saving rates and domestic investment rates.
Maurice Obstfeld
Department of Economics
Columbia University
New York, NY 10027
(212) 280—5489
Introducti on
I.
Since
real
in terest
rates around the war Id have risen
era.
and remained at levels unprecedented in the postwar
While the
he won dwi de nature
increase in real rates awaits a full expi an ation, t
e. Both widespr ead f i nanc i
of the phenomenon is itself less of a puzzl
on techn ol
ogi es
al
have cr eated close
industr i
linkages among the financial market s of the
al ized
c oun tries.
interriat ional ly mobile1
Economic theory suggests that if cap ital is
move in a
rates of return in different countri es will tend to
synchronized fashion as inve stor
toward assets offering relat i
s conti nual
ly shift their portfolios
said to be
high yiel ds. Capit al is
vel y
resident s may engage in
mobile between two regions i f som e of their
inter—regional
Car r espon dingi
asset trades.
y, the de gr
ee
of capital
sco pe which might
mobility is measured by the scope for such trades, a
be limited by transaction coits,
How mobile is
capital
tax e S
or off i ci al
regu 1
ati ons.
in t he wor 1 d ec onomy? E mpi ri cal research
twa ma)Or ii nes. The first line
into thi s question has proc eeded along
S
4 resea rch is based on the comparison of expected yield
on alternative
ne of researc h, or iginated by
assets. The second, and more novel, ii
Fel dste in
and Horioka 19B0)
is based on
saving and domestic investment rates.
the
cOffpa r i son
of national
lii an economy that is closed to
nati onal saving and
intert emporal trade with the outside world, overall
dome st ic investment 'ust be equal
bal anc e
that is, the cur rent account of the
i
of payments must be zero. The FeldsteirvHor
based on the premise that the degree f car r
e 1 at i or
a k a
approach is
bet ween saving and
investment rates is therefore a barometer of the extent of capital
mobility.
Th is paper is
critical
a
assessment of some recen t empir i
cal
evidence or the extent of inter national capi tal mobilit y. Free capi tal
mobility is in general a necess ary condition for the ef +
tional allocat ion of the world' s saving.
i ci ent
interna—
The efficient all oca tion of
risks in the w orld economy requ ires internati onal asset trade and the
portfolio dive rsification it al lows. Further, the extent to whi ch capi—
tal is mobile is important in a ssessing the e fficacy of financi al
policies in op en economies, the incidence of certain taxes, and the
impact on capi tal accumulation of changes in government and pri vate
saving. The di scussion emphasi zes that concl usi ons about effici ency
cannot be drawn from an y set 0 f empiri cal resul ts unless some b enchmar k
model of an "eff icie n
Similarly, posit i
ye
wor 1 d
t
economy is specif ied in advance.
as well as normat ive conclu sions are extremel y
sensitive to the emp in cal assumption s embedded in the benchmark model.
The remain der of thi s paper is organized as follows:
Section II de scr ibes recent wor k on the relation between measured
rates of return on ass ets denomi nated in diff erent currencies. It is
argued that in mo dels of any generali ty, the observed internati onal
linkages between these
r
ates may be 1 oose ev en if there are no serious
imperfections in world
c
api tal markets. The di scussion suggests that the
tests most likely to be
i nf
ormative about the extent of capital mobility
involve assets de nomi nat ed in the same currenc y but issued in di f
f er en t
political or regu 1 atory jun isdictions. Availab le evidence is con si stent
with strong cross —border
li
nkages between OECD —country capital m arkets.
Section III descri bes the Feldstein—Hori oka approach and r esul ts,
and then presents a life-cycle model in which countries' saving and
investment rates are correlated even though capital is perfectly mobile.
A simulated regression using data generated by the model yields es—
timates quite similar to those found by Feldstein arid
ot her S.
However, the policy implications
differen t
Horioka
of the estimates
from those that are usually drawn • For example,
and
are very
+ I scal
policies that encoura ge saving have no effe ct on domestic capita 1 stocks
in spite of the stron g statistical correlat ion between lon 9—run savi rig
and inves tment rates.
The empirical { indings of Feldstei n and Horioka are for the most
part based on cross—s ectional c omparisons of countries saving and
I nvestment
rates over periods of five years or more. Sections IV through
Vi of this paper explore the savi ng—in vest merit
relation
in a short—run,
time— series context.
Section IV develops a si mple open—economy model suitable for
anal yz ing
comovements between innovations in saving and innovations in
invest merit. Both Feldstein (1983) and Murphy (1984) have used aggrega—
tive I S—LPI
models for this purpose
but the modelling strategy here is
differ ent in that the possibility of a saving—investment correlation is
derive d explicitly from the maximi zing behavior of households and firms
rather than imposed a priori.
The model of section IV highli qhts the fact that data from na—
income accounts do not yield an ac curate represent ation o + na-
tiorial
tional saving in a world where share s in the ownership of domest ic firms
can be held by foreigners. Section V show s
measur ed correlations between saving and
ho
this probi em can i ncrease
i n vest m en t
Section Vi presents estimates of th e tire-series
bet wee n
correlion
quarterly changes in saving rates and in invest ment rates fr
seven OECD countries. although these esti mates need to be interpreted
with c autior, they provide empirical fact s with which macroeconomic
theories must be consistent. The estimated correlation coefficients turn
—4—
out to be highest for economies which are either very large (the United
States) or have had extensve c apital controls over much of the sample
period (Japan). The y are smalle r for medium—sized countries, and may be
insignificantly dif ferent from zero for the smallest economies. In all
cases but those of the U.S. and Japan, the estimated saving—investment
correlations over t he entire sa mple period considered differ sig—
nificantly from the value of 1 that would obtain under complete capital
for six of the seven countries, the measured cor—
immobility. Further
relation drops in t he period af ter 1972. An interpretation of the data
consistent with the se findings is suggested. This interpretation, which
postulates substant ial and incr easing capital mobility among OECD
countries, receives
i ndi re ct
support from evidence on the United Kingdom
under the pre—1914 gold st and ard.
The papers m am
II.
con clusions are summarized in section VII.
Inte rest, Exch ange Rates, and Inflation
The international integrati on of natio nal financial markets im—
plies important linkage s between the ret urns off ered by assets issued in
different countries. Th ese links can be weak ened by transaction costs,
taxes, capital controls
sovereig n ri sk, and other market imperfections.
Even in the absence of imperfecti ons, th e na ture of the 1 inkage depends
on investors preferen ces and the stochastic structure of the world
economy. The most stra i
capital is the direct
ghtf or ward
c omp ar i
approach t o evaluating the mobility of
son of rates of return on ph ysical capital
in various countries. Al thoug h such comparisons have been attempted (for
example, by Harberqer (1978))
the problems of measuremen t, of diverse
ta treatment, and of converting measured returns into
a common
numeraire, are severe. Much recent research has therefore limited itself
t
rather
to comparing returns within a
narrowly delimited group of rela—
tivEly homomoeneous financial assets.
It is convenient to mot ivate some of the recent empirical tests on
international rate of return linkages b
model of international nomina 1 inte r
es t
developing a simple two—good
rate differenti als wi th ri sk -
4
averse investors. The model makes the point that many of the empi
ri cal
tests have unambiguous implic ati ons ab out capital mobil ity on ly un der
some rather stringent assumpt ions. It
the c ompar i sons
mOst likely to be informative about the extent of international capital
mobility involve assets denomi nated in the same currency but issued in
different countries.
There are two countries in the world, a "home" country and a
'foreign' country, each with its own, country—specific currency. On any
date t, the domestic—money p rice of a unit of domestic currency to be
deliver ed with cert ainty on date t+l is just 11(1 +
where Rt is the
domesti c nominal in terest r ate. The foreign nominal interest rate
is
similar ly defined, and the spot exchange rate, X, gives the price of a
unit of foreign cur rency d elivered at time t in terms of a unit of home
cur r enc
y also deliv ered at time t. Note that the nominal interest rates
thet ha ye just beer defined are risk—free nominal rates. Each country is
special i:ed in the product i on of its characteristic output. The
do ire s t i
d e ot e E
c—mon ey price of home output at time t is denoted P, while
the
I n d i
vi
f ore i g n —
d u a 1 s
cur r
en c y
price of foreign output.
in the two countries have identical, time—separable
utlity functions of the form
wherr Ett. is e, orditional expectation based on time—t information,
s lisa fixed subjective time—preference rate, c (c) is time—t con—
5 U l) pt i on
o tho hose (fore ign) good, and the ins tantaneous util I ty
is
4 unction u(. ,.)
stricti y concave. Given these preferences, w hat
condition s will characteri ze asset—market equili brium in the ab sence of
imperfect ions? Consider th e position of a repres entative invest or. If
there are no cash—in—advan ce constraints, he may use a domestic currency
unit to i ncrease consumpti on of the home good to day, to increas e con—
sumpti on
tomorrow after a one—period investment in domestic—cur rency
loans1 o r to 1 n crease cons umption tomorrow after a one—period i nvestment
in forei gn—cur rency 1 oans; and in equilibrium, h e must be indif ferent
among th ese three alt ernatives. Define u
u(ct.c)i
Then the implied in tertemporal arbit raqe conditions are
u4 (c ,c
/P
(1) u
=
c,t
c,t
t
= E t [(I+Rt )u c,t+l/Pt+l )
= 5E
t [c1+R:)Xt+iuct+i/Pt+i)/Xt.
Because the marginal rate of substitution between current consumption of
home goods and current consumption of foreign goods foreign goods always
equals the relative price of those goods,
(2) u
/u
=
c4,t c,t
(1) implies that the indivi dual is also indifferent be tween consuming
the foreign good today and shifting that consumption + orward a period
through an investment in do mestic or foreign bonds.
-3
The second equality i n (1) may be rewritten in a way that ii—
lustrates the link between nominal interest rates and the exchange rate.
Let CovtL) denote a covari ante conditional on time—t information. Then
(1) implies that
1+R
I
+
E (X
Et(ut+i/Pt÷i)EtXi)
—7-
Expression (3) revea is that, absent imper fections, the nominal interest
differential between the home and foreign currencies is
two factors. First1 there is the expected
currency against the foreign currency, Et
depreciation
determined by
of the domestic
Seconds there is the
covariance term, whi ch may be interpreted as a risk premium.
The intuition behind the covariance term in (3) is as fo 11 ow; The
quantity ut+i/Pt+i measures the marginal consumption value o f the
domestic currency at time t+1, the utility obtained then by sp ending
another unit of home money to consume the domestic good. (By
2), this
is the same as the u tility that would be obtained by spending the money
to raise consumption of the foreign good. ] The greater is the covariance
between the future ex change rate
and the marginal consum ption value
of domestic currency, the more effective is the foreign bond relative to
the domestic bond as a hedge against cons umption risk. This i s because
the stochastic payoff on foreign assets, in terms of domestic c urrency
tends to be surprisin gly high when the consumption value of the currency
is surprisingly high.
rise in this covariance therefore leads to a
fall i n the nominal i nterest rate on foreign bonds relative to that on
domest ic bond;.
when the ris p remium in (3) is zero, interest rates are linked by
the uncovered interest parity condition
(4> (R —
R)/(1
+
R)
(Et(Xt +i) —
which relates the interest d iff erential exclusively to expected
depreciation. Under the assumpt ion that expectation; are rational,
approximations to condition (4> have been tested extensively on recent
data. These tests are unani mous in rejecting the condition as a charac—
terization of asset—market equi 1 ibrium
[see Cumby and Dbstfeld
—8—
Hansen and Hodrick (1980,1983), Hodrick and Srivastava
1981,1584),
(i5S4,19B)
, and the references therein]. But it should be clear that
6
the assumptions required to proceed from (3) to (4) are not innocuous.
Most authors ha ye therefore regarded rejections of (4) as indicating the
presence of a t ime—varying
rationality or
market imperfections. Because expectations (and, by
implication, r isk
premia) are not directly observable, this is just one
of several pos sible
assumptions
on
consumption risk premium rather than ir—
interpretations. Only after making some strong prior
expectations and the nature of the risk premium can one
extract conclu sions about the functioning of international asset markets
from
test; of (4). 7
it
noteworthy that the concept of uncovered interest parity may
is
be well defined.
not always
By using (2), one can manipulate (3) to
obtain
1 +
IC
—
1
B;
=
+
1JX,
whi ch is
jus t
cur rency
If
hol d
bec ause
1/Et(X+i.
only
Et(1/Xt+i)
equation
Coy (u
t c*
I E tc*,t+i/F )E (1/X
+1
t
+
t+1
3) viewed from the perspective of the foreign
the risk pr emium in (5) is zer o, (4) will not generally
by Jensen' s inequality, Et (1/ Xt+i) need not equal
In fact
unc overed interest par ity can be uniquely defined
in a nonstocha stic
"Siegel's paradox"
environment. Th is 4 act
is sometimes called
(Sieg ml (1972)].
Tests of unco vered
interest parity typically use interest rates on
Euroc urrenc y deposi ts, which, unlike U.S. Treasury bills, are not widely
believed to be free of default risk. This raises two further problems of
interpretation. The first of these arises from the assumption underlying
(3) that interest rates are risk free—rates. The second problem, which
—9—
is more serious, involves the question of whether inferences concerning
international capital mobility can in fact be made from the tests.
The pres ence of default risk indicates t hat the reasoning leading
to (3) or (5) is not valid when ap plied to Eur ocurrency rates. The use
of Eurocurrenc y rates is typically justified, however, by the argument
that Eurocurre ncy deposits have id entical risk characteristics (at least
when issued by the same bank). And indeed, a p articular formalization of
this idea does yield (3) and (5). Suppose that the Eurobank honors its
deposits with probability E t+1 on date t+1 but defaults with probability
payl ng depositors
1 —
random variabl e that assumes t he value 1 with probability
val ue 0 with probability
1 —
be a
no co mpensation in that case. Let
c1
and the
Then the sto chastic payoff on
cur r enc y Eurodeposits is Q t+1 (1 + Rt) with an expected value of
II
t+1
(1 +
R
t 1)
=
+
Eur odep osits is
If
Qt+1
is
1 +
t+1
while that on
wit h
an exp ected value of
+ R).
distributed I ndependentl y of all other relevant variables,
then conditions (3) and (5) follow exactly as bef ore. Of c ourse, a
failure of the f oregoi ng independence assumpti on makes it even more
difficult than o therwi se to interpret rejectio ns of condi tion (4).
The second problem of interpretatiDn is th at tests of interest
pan t y based exc 1
in for cation
usi vel y
on Eurocurrency rates 5imply may not yield any
abou t the ex tent of capital mobility among countries. These
tests typically assess the efficiency of arbitr age among deposits issued
in a s inqle 1 ocal
issued ir dif f
i ty
er ent
(for example, London). (.inIe ss tests involve assets
countries, they can tell us little ab out the ease
with w hich re i dent s of those countries can engage in mt ertemporal
trades
This po nt would be irrelevant if nominal yields on assets
derosinated in the same currency but issued in different oolitical
—itj—
3 ur
4 or
isdictions were equal. hut casual observation reveals discrepancies,
reasons that may involve heterogeneity in terms of default risk3
soy ereiqn risk, and tax treatment, as well as existing capital controls
and other financial regulations [see Aliber (1973) and Dooley and Isard
(1980)
indeed, any attempt to measure capital mobility using rates of
return must b e based, not on a comparison of Eurocurrenc y rates, but on
a comparison of nominal yi elds on 'onshore" and "offshor e" assets
denominated i n the same cu rrency——for example, large dol lar certi ficates
of deposit is sued by New V ork banks and those issued by London ba n
k s.
These rates g enerally do d iffer, as noted above, but fo r many cur renc
i es
they have ten ded to move t ogether in recent years [see Fieleke (1 982)
chart 11.
Johnsto n (1979) finds that after correction for differential
financial req ulations, Eurodollar and Eurodeutschemar k rates are always
quite close t o the interest rates paid on comparable liabilities of
onshore banks (at least after 1973 for dollar rates a nd after mid—1973
for Dli rates).
In a very careful study accounting for bid—ask spreads
and the cost a f deposit insurance as w eli as differen tial reserve re—
quirements, Kr eicher (1982) finds that over the 1975- 198C' period, the
difference bet ween Eurodollar and U.S. certificate—of —deposit rates
afforded banks little or no opportunit y for arbitrage
Hartman (1984)
presents evide nce of significant two—way feedback between Eurodollar
deposit rates and interest rates on commercial paper issued in the U.S
When ca pital controls are known to have been important, there are
still links b etween onshore and offshore interest rates, but also some
important di screpancies. Siavazzi and Pagano (1984) show that for France
and Italy, these discrepancies have been largest around the time of
-11--
exchange—rate realignments within the European Monetary System (EMS). In
contrast, these authors find a close connection between onshore and
offshore rates for Germany and the Netherlands, two EMS countries with
essentially open capital markets. Rogoff (1985) also presents evidence
that capital controls have helped the French and Italian authorities
maintain EMS—linked exchange rates. Ito (1983) documents the existence
of apparent arbitrage opportunities between Japanese Gensaki repurchase
agreements and Eurocurrency deposits during the 1970s, when Japanese
capital controls were stringent. However, he shows that these opportunities became very infrequent once Japanese capital markets were
effectively opened in December 1980.
10
On the whole, therefore, data on onshore—offshore interest differentials imply a substantial degree of capital mobility among OECD
countries. In the face of this strong evidence of efficient international portfolio allocation at each point in time, it is difficult to
understand assertions that the allocation of portfolios over time
somehow consistent with substantial arbitrage opportunities.
No explicit mention has been made of the international linkage
among expected real rates of interest, defined as nominal rates corrected for expected local price—level inflation. The reason is that the
theory outlined above makes no strong predictions about real interest
rates so defined. This point is illustrated through the assumption that
the interest parity condition (4) holds. Define the domestic inflation
—
=
rate as
—
1.
If
1
and the foreign inflation rate as 11
denotes the terms of trade XtF/Pt and if
Ft/P are distributed independently, then (4) can be written
(6) (Rt R/(1+R = [Et(tt+i)/7t)Et[(1+t+i/1+U*i)) -1.
and
I'
Note that iin addition, the terms of trade are expected to remain
constant over timp, (6) assumes the form
(7) (R — R:)I(l+R:) =
EtC(Iti
*
1+11*
)]
which explains relative nominal interest rates by expected relative
inflation rates. A very crude approximation to (7) is
Rt
—
=
Et(llt+i
*
Rt —
*
the usual statement of the international equality of expected real
interest rat es. But even when (4) holds, the equality (7) leading to
this approxi mati on follows only if one mak es some exceedingly strong
assumptions, inc luding the assumpti on that the relative price of na—
tional outpu ts f ollows a martingale pr oces s. This last assumption is
sometimes ca 11
ed
ex ante purchasing power parity, and while there is
some support for it in the data, it can b e statistically rejected in
see Cumby and Ubstfeld (1984)].
many cases
The eq ual
i
ty of expect ed real rates has been tested, for both
onshore and offshore nomi nal rates, in a series of papers by Hodrick
1979)
Howard (1979
(1984), and Mishkin
tions
of
Cumby and Mi shkin (1985), Cumby and Obstfeld
(l984a, 19 84b)
In li ght of the rather strong rejec—
uncovered p arity and ex a nte p urchasing power parity, is it is
not surp rising that most of these tests reject the hypothesis that
expected real rates are equal acro ss cur rencies. Nonetheless1 the
bi 1 atera 1
correlatio ns computed by Cumby and Mishkin (1985) show that ex
ante rea I rates tend to move together, even when defined using onshore
interest rates. Thei r finding r einforces the impression of significant
capital mobility among OECD countries.
III. Saving, Investment, and Capital Mobil ity
While international comparisons of interest rates yield indirect
evidence
on the mobility o 4 capital among countries1 the connection
between a c ountry's income and its expenditure yields a direct measure
of the exte nt of its inter temporal trade with the rest o4 the world.
When a coun try i s completely closed to
capi t al
may ements, its income
necessarily equa is its spending on consumpti on and investment goods. In
contrast, c ountr ies that are integrated into the w arId capital market
may
finance
disc repancies between income and spend ing through inter na—
tional borr owing
In
a
pair
or lending.
of stimulating papers, Feldstein and Horiok a (1980) and
1983) have attempted to use measured discrepanci es between
Feld stein
national in comes and ependitur es to assess the degree of i nternational
financial integrati on. To motivate their approach, let V denote national
income, C private c onsumption, I domestic investment, and 6 government
consumption. In an economy closed to international cap ital movements1
total national savi ng S =
V
— C — 6
necessarily equals domestic invest—
ment I. The current account of the balance of payments
=V
is n ecesarily
t
r ad e,
S
(C + 1
—
4
6)
S —
given by
I,
zero in this case. For an
economy open to external asset
and I need not coincide and th eref
ore can vary independently in
equi librium. For example, when national saving exceeds domestic
nyc stment,the
C U S U lating
economy is running a curr ent—account
net claims on the rest of the world's future output. Th
Fel d stein—Horioa
iorld of perfect
moveserits
surplus and ac—
analysis is predicated
an the contention that in a
capital mobili ty, movements in domestic
in nat ioral saving wi Il be approximat ely
investment and
uncor related. s they
—14—
put it, "With perfect world capital mobility, there should be no relation between domesti c saving and domestic investment: saving in each
country responds to the worldwide opportunities for investmen t while
investment in that c ountry if financed by the worldwide pool
of
capital.' tFeldstein and Horioka (1980), p. 317.]
The statistica 1 analysis in these papers is based on regression
equations of the form
(8) (116DM. =
1
0
4- i (816DM.
1
1
where 6DP is nominal gross domestic product, the left— and right—h and
side variabi es are averages of annual ratios of gross nominal investment
and saving t o GOP over periods ranging in length from five to twenty
years, and t he index i ranges over a cross—section of DECO cou ntries. A
finding that
differs significantly from 0 is viewed as beinq incon—
sistent with perfect capital mobility, while a value of
to represent the case of complete capital immobility.
=
1
is taken
11
Over t he period 1960—1974, for example, the least—squares estimate
reported in Feldstein and Horioka (1980), table 2, is
0
= 0.035
= 0.887,
(0.018)
0.91.
R2 =
(0. 074)
Regressions using net, rather than gross, savi nç and investment yield
estimates of
even closer to 1. Because
s repeatedly estimated to
be significantly different from zero but not 5igni ficantl y different
from 1, the authors conclude that capital mobi lity is rot perfect and
that most of any increment to national saving ends up augmonting the
domestic capital stock. The estimated vlus of
is interpreted as
1
measurinq the effect o
&
sustained
increase i n a country's saving rate
on its investsert rats, The strong policy impl ication drawn from this
— 15—
interpretation is that policies to encourage domestic saving will have
an effect on domestic investment that is essentially one—f or—one.
I'
The bal anc e of this section argues that the res ul ts reported in
Feldstein and
Nor i
oka (1980) and in Feldstein (1983) do no t necessarily
have any i mpl icati ons regarding t he extent of capital mobi lity. Common
factors af fec ting both saving and investment rates may
c au se
these
variables to be hi ghly correlated in cross—sectional d ata. But such high
measured c or
r el ati
ons do not impl y that y shift in n atio nal saving,
would be the
regardless of its source, affects domestic investment, as
case under capital immobility. A c orol I ary of this arg ume nt is that
policies th at increase domestic sa ving rat es may have no effect on
domestic in vestment rates even if regr essi ons like (8) yi eld large and
41
£ ,J
statistical ly significant least—sq uares es timates of
These points are established within the context
a life—cycle
model of sa ving and growth in the world ec onomy. The mod el is designed
the longer
to capture forces influencing savi ng and i
term. First
the theoretical predi cti ons of the model ar e established.
These include a possibly positive cross—sectional correl ation between
investment and saving rates1 but a zero ef fect on i nvest ment of policies
that encourage
savi n g
within an i ndivi d ual cou ntry. Seco nd, it is
demonstrated th rough simulate d re gressi on anal ysis that the theoretical
model is capabi e of producing emp irical r esult 5 sim i
reported in the Feldstein—Hor i
Consi der
o k a
studi es.
1 ar
to those
14
a 5mall open econ omy wh ich produces and consumes the
single consumpt ion good avail able in the world. Individuals live for two
periods and are endowed with a un it of I abor which is sold in the first
period of life at a real wage w. The labor endowment of an 0 ld in—
di vidual
is 2ero, so all old—age cons umption is financed thr ough wealth
- là—
accumulated while younq. Wealth may be held in the form of domestic
capital or in th form of an internationally—traded bond which costs one
unit of the consumption good and pays its owner p units of consumption
after a period. F is just the world rate of interest, and it is a
parameter from the standpoint of the small economy.
Output y is a function fR'in) of domestic capital and labor.
H.,.) exhibits standard properties, including constant returns. The
labor force is assumed to equal (l+g)t, and therefore grows at rate g.
Labor cannot migrate across national boundaries. A unit of saving may be
costlessly transformed into a unit of installed capital a period later,
and capital depreciates in use at rate .
by the conditions p +
S
=
fk(k1n)
wt =
Equilibrium
fn(ktntl
is characterized
and n =
(1g)t
the production function is taken to be of the form kmnlm, these
equalities imply that for all t
(9) k = (i+g) (u/p*F) 1/1—a
t
(10) w w =
(11) Vt =
Let
(1—u
(l+g)t(a/p+fl
c denote
an
u/i—u
individual s consumption in period t. Then the
lifetime problem of an individual young at time
(12) u(ct) +
t
is to maximize
fiu(c+1)
subject to the constraint
(13) c +
c+1/(l+r)
r
w.
If it is assumed that the subjective time preference factor p equals
l/l+p, maximization of (12) subject to (13) results in a preferred
If
-17-
individual consumption path that is flat at the level
(14) c =
(1+p)wf(2+p)
and the same
for
each member of each generat ion.
net saving in this economy,
Ag o req ate
consists of the saving
o the young plu s the (negative) saving of t he old:
(15) St =
(Hg
(w —
c)
4
Hg)
t—1
[p(w — c)
— c].
Equations (14) and (15) imply that
(16) St = g(1+g)
t—1
wI (2+p)
and equat ions (10) and (11) may be combined with (16) to obtain the
ratio of net saving to gross domestic product
=
(17)
6DPt)
(g/1#g)[(1—u)/(2+p)3.
Net investment
(IS) I =
(
— kt
is given by
=
g( Hg) (a/p+fl
1/ 1-m
according to (9). By (11),
t19) It/6DPt
g(ufp+E).
The most important fact to note is that because a rise in the
population growth rate g causes both the saving rate given in (17) and
the investment rate given in (19) to rise, these variables can be corre—
lated in a cross—section of countries, in spite of the perfect mobility
of capital.1 Saving rates are increasing functions of population growth
rates for the standard life—cycle reasons [as set forth in tiodigliani
(1970), for example): the more quickly the economy grows, the lower the
weight in the aggregate saving ratio of dissaving by the old. Invest—
sent, however, depe nds on population growth for reasons that are uncon—
nected with saving
b e h a vi
capital stock must
i
or: as the e+fectiv e la bor force increases, the
ncrea se in proportion to
mai ntain the equality
between the net mar ginal product of capital and the world rate of
return. It is reall '
the international immob ilit y of labor that is
behind the saving—i nvestm ent correlation in this model.
Nc.te, however
that saving and investm ent rates will be negatively
correlated in a cross—section al sample if gr owth rates are fairly
uniform acr ass countries but there are wide disp arities in the values of
capital's share a.
Can the theoret ical mod el developed here yield regression results
similar to those foun d by Eel dstein and Horioka (1980) and Feldstein
(1983)? To answer thi 5 questi on the model was calibrated usi ng data on
growth rates and the function al distribution of income for the seventeen
OECD countries listed in tabl e 1 of Eeldstein (1983). In thi s model
world economy, the li fespan o + a generation was taken to be a year, p
was set at .1, and t was set at 1 (implying that capital is used up
camp
men t
1 etel y
in produc tion). 4 scatter diagram for the saving and invest—
rates generated by (17) and (19) is shown in figure 1.
16
Estimation of (8) by ordinary least squares using the simulated
data set yields
0
0.006,
(0.0(1)
= 0.858,
=
0.07.
very
cl ose
(0.806)
While the estimate of the si ope coeff icient
is
to those
obtai ned in the literature, this para meter is impr eci sely estimated, and
does not differ significantl y from 0 or 1. However
that "Greece' is an extreme
out 11 er
in this sample
figure 1 indicates
(1 argel
y because of
0.00500
0.0050
0.0100
o.oiso
0.0200
0.0250
Invs stmsnt
rots
I
0.00650
I
Swedsn
I
• United Kingdom
Germiny
Italy
•
Denmark •
•
•
Sellvm
Austrafla
Francs
•
0.00950
I
31,1111
1
I
0.01100
I United St.,..
• Ireland
Netherlands
I
(Simulatid data)
0.00800
I
•
Austria
New Zealand
Finland
Ir•ecS
Figure
0.01250
Saving rotS
CIMdI
-19—
the un usually low share of employee compensation in national income, an
art
i
a ct of severely distorted data). Omitting that
-=
1.422,
C.'
0. U 04
(0.
45)
F
observation
4.
yields
u.41.
—
In thi s equati or the esti mated slope coefficient is significantly dif—
ferent from
and insigni ficantly different from 1. The equation is
therefore quite close to the type of result found in the Feldstein—
Horioka literature,
al
though the
is only about half as large as those
typically reported there.
The preceding
the Fel dstein—
Horioka findin gs are consistent with perf ect capital mobili ty. They also
show
that
it i s ha:ardous to make predict ions on the basis of such
regressions wi thout knowledge of the economic model underly mg
the
measured corre lation. It is true, in the theoretical model, that an
increase in th e saving rate caused by an increase in the ec onomy 's
investment
growth rate wi 11 be associated with a ri se in the domestic
rate. This fac t lies behind the large and significant slop e coefficient
in the regress ions. But it does not follow that j ri se I
n
saving will
be accompanied by an increase in investment. For eamp le,
a
rise in the
saving rate in duced by tax policies that do not affect fir s will leave
the investment rate unchanged any increment to saving
abroad in
that
wi 1
I
I
ndeed flow
case. The example warns us that the reg ress ion results,
taken by therns elves, are an insufficient basis for pol icy for mul at ion.
While th e foregoing counter—example is driven en ti
growth1
it is
investment
not clear that growth alone can account
r
ly by economic
f or
the saving and
rat es seen in the real—world data. Modigli ani
197 0), in a
cross—country study, 4ind that growth rates are an import ant deter—
irinant of saving rates. However, there is an increasing body of evidence
—20 —
flat lifc—cvcle considerations alone
are insufficient to explain na—
tional saving
behavior in the U.S.
hctli(:off
Summers (1961)1. Feld stei n and Ho rioka (1960) test for the
importance
arid
and ml sewher e [see, for example,
cf growth by adding the
rate
income arowth to their basic
equation (6). But while the t—statistic for the new regressor is 1.45,
high correlation between saving and
a
investment rates remains. Summers
(1965) finds a highly significant co efficient on
population growth when
that variable and the rate of income growth ar e added as regressors. An
investment—saving correlation of 0.61 remains, but the Summers result
contradicts the hypothesis that domestic inves tment depends only on
domestic saving in the long run. It i s an open question whether more
realistic intergenerational models, i n
corp or at ing
country—specific demographic and inst i
tut i onal
bequests as well as
factors, can explain the
observed behavior of current accounts over lon q periods. The preceding
simulation example should not be taken
as an e xpianation
Feldatein—Horioka results. It should be taken as
tions other than capital immobility are quite
of the
evidence that
possible.
expl ana—
Future research
should aim at identifying and testing the potential alternative
e x p1 a n
at on s.
17
I
Another question that has
not been answered i s why OECD current
accounts have been so small rel ative to saving over most of the post—
1960 period [see Feldstein and Horioka ( 1980)
Recall that the current account measures
a country and the rest of the worId.
and the fact that gross capital
and F i el eke (1962)].
the net +1 ow of
Both the resul ts
flows have been lar ge
capital between
of this section
sug gest
that small
current—account imbalances are n ot evidenc e of capi tal im mobility. A
further r mason why small current ac counts need
not imply capital immobi—
lity is tt a countrys bilateral current account with respect to an
individual trading partner not infrequently exceeds the difference
between its t otal sa ving and invest ment.
that definiti ons
LI
SeU
reduce the me asu red
lB
Secti on V. below, points out
in national I ncome statist ics may artificially
var i
a bility of current accou nts
Howe'er, the em—
pirical impor tan cc o + thi s distort ion is unknown at present. Tobin
t1983) ,
Westp hal
(19 83)
Summers
1985) ,
and othe rs have suggested that
governments m ay targ et th e current account over t he long run through
fiscal measur es desi gned to offset changes in pri va te spending. The
extent to whi ch
small size of
c
er do genou s
fiscal policy reaction
urren t—account
mb alances
s responsible for the
is, agai n
an open question;
Summers (1985) prese nts some inst rumental—variabl ee stimates that appear
to support this
e x p1
anati on.
It s hould be reitera ted
however, that the
simulation re suits repor ted above show that a str ong cross—sectional
savi ng—i nvest ment covar i ation is consistent with per fect capital
mobility even in the absence of such current—account targeting.
IV. Time—Ser in Covariation between Saving and Invest.ent: An Example
Section III explored the i nterpretati on of cross—sectional
cor -
relations between long—run average saving and i nvestmen t rates. The
Feldstein—Horioka reasoning impi ies also that the time— series correla—
tion between changes in saving r ates and chan ges in mv estment rates
should be zero as well if capitaI mobility is perfect. This section
discusses this proposition at a theoretical 1 evel show ing that its
validity will depend on the nat ure of the sho cks imping ing on the
economy. The discussion serves as a backgroun d for the estimation of
time—series saving—i nvestment correlations in section V 1, below.
4 simple intertemporal model of a small open econ omy illustrates
one channel leading to a posi tive time—series correlati on between in—
n
novations in saving and
innovations
in
investment. That channel is the
response of both saving and investment to temporary shifts in the
productivity of domestic capital and 1 a bor. Say ma
and
investment may
move together in the short run even if domestic firms are entirely
foreign owned. The essential reason for this co movement is again the
fact that labor is not mobile across na tional b oundaries. An increase in
domestic factor productivity therefore entails an increase in the domes—
tic wage; and if this increase is suffi ciently transient, saving will
rise as suppliers of labor spread it cv er all + uture periods.
The model is deliberately kept as simple as possible; in par—
ticular, a nonstochastic environment is assumed • While a stochastic
setup would of course be necessary to develop r igorously the model s
empirical implications, my goal here is merely to illustrate an aspect
of the saving—investment link in open ec onomi es
The possibly dif-
ferent identities of the agents who make saving decisions and those who
make investment decisions is highlighted below b y the presence of a
stock market and value—maximizing firms. However
the competitive equi—
librium naturally I eads to the same allocation of resources that a
central planner wou ld choose.
A small open economy faces a perfect world capital market, In—
dividuals consume a single good which may also be transformed into a
unit of capital or lent abroad at the interest rate p. The world capital
market is perfect i n the sense that individuals may lend or borrow any
amount they wish at the rate r,
subject
to a lifetime budget constraint
to be discussed bel ow. All loans are again denominated in units of the
single consumption good.
The represen t ative immortal consumer has a fixed labor endowment
(normalized at uni t y) which he sells domestically at the wage rate w at
tine t. H
holds his nonhuean wealth at time t in the form of claims on
foreianers (possibly neative) and shares ht (0
of the single domestic
firm.
ht s
1) in
the profits
Shares pay dividerds (and bonds pay inter-
est) after a period. Let dt denote the dividends the domestic firm pays
out in period t and
the firms e—dividend (or end—of—period) market
alue. Necessary conditions for the optimal individual consumption plan
under perfect foresiaht may be derived by maximizing the consumers
objective function
(20)
E u(ct)
t—1
w
subject to
+
(21)
An implication
+ (1+p)btj — c
Nt +
bt
(t
1).
of the necessary conditions is that in a perfect—
foresight equi librium, shares in the domestic firm offer a rate of
return equal t o the wor Id interest rate:
(22) (q
+d
—
t+1
t+i 1/
=
p.
= l/(l+p)
The si mplifying assumption
yi
elds the further implication
that i ndividuals choose a perfectly flat consumption path.
Consumption is flat at the highest constant level that allows the
lifetime budget constraint
(23) 1(1+p)
t—1
(ct -
wt)
(q1+d1)h0+
(1+P)b
to hold as an equality. The implied consumption function is
4 (1+p)b1 + Ej0 (1+p — w t+j
(24) c
for all t
1.
—24—
Consider next t he
The firm is
in
labelled
behaior of the repr esentative domestic
+ i
r m.
"dome'stict not because it is owned entirel y or even
part by domestic r esidents, but because i ts capital cooperat es with
domestic labor in the production of output. The firm chooses a progr am
of production and mv estment that maximizes its beginning—of—p er
value
v, equal to the
dividends.
i od
discounted present vol ue of current and future
In the Mod igi iani —Mi 11cr environe ent that has been assumed,
it makes no differenc e how the firm finances its investment. It is
convenient to assume that the firm does so e ntirely through retained
20
earni ngs.
Output at time t, yt, is a constant—returns f unc tion
labor
domestic capital
and a factor—product i
vi
etftn) of
ty disturbance
Capital may be instal led costle ssly, and it depreci ate s in use at rate
I. Installation takes a period, however, and instal led capital may not
be removed from produ ction unti I the fall owing pen od.
(In other words,
the stock of capital
unlike th e labor input, is a pre determined
variable.) The firm's
max i mand,
the present discoun ted value of its
stream of dividend pa yments Cdi!i may therefore be written:
(25) v =
r
0(l4p) [e+f(k+.tn+.)
Equation (22) i mplies that v =
q
4
-
— kt+i+i + (l—flkt+.].
dt.
The probl em's solution calls for investment and employment paths
such that
t F'
(26)
(27) &f n(k t,n I =
t
w
t
——C—
for
all t (although the ;niti0l capital stoc( is not subject to choice).
Notice that when rules (26) and (27) are followed, the ex—dividend value
of the firm is given by
(28)
t the end of the market period, the firms value must equal the stock
of capital that has been put in place to participate in next period's
producti on.
In equilibrium, the firms demand for labor equals the available
domestic labor force;
(29)
1.
To be concrete, take once again the Cobb—Douglas case f (k,n) =
kDn.
Then the equilibrium capital stock and wage in each period are given by
(30) kt =
(31)
(l_u)[u/p+t)tulm(et)
Net saving in period t, denoted S, is given by
(32) St =
Let v =
w
+
81/lu
(q
+
dt
—
1)h1
+
Pbti
—
c.
Equations (22), (24), and (32) imply that along a
perfect—foresight equilibrium path,
( St w —
= (l_u)[m/p+flmfl
-
PEo(1+P)vt+].
Equation (30) implies that the perfect—foresiqht level of net investment
in period t,
is
(34) It =
kt+i
-
kt
=
(vt+i
-
Consider now an una nticipated rise in the productivity p araseter
which had previously been expected to be constant at the level v. The
shock occurs in period 1, and, as will be shown, it qenerally causes
both national saving and domestic investee nt to causes in that pen od.
Equations (33) and (34)
which presuppose perfect foresight, a re ap-
plicable after period 1 p rovided no furth er unanticipated dist urbances
occur. But because k1 i s predetermined an d was chosen on the b asis of
mistaken expectations, Si and I must be calculated from first
pr in—
ciples. I will assume that from period 1 onward, the productiv ity dis—
turbance follows the path
(35) Vt t
For N
V + At-.1
(V-1
— i.)
(0 < A S
1).
< 1, (35) represents a transitory increase in productivity from
i'
to v' that decays at rate A. For N = 1, the productivity increase is
permanent.
In period 0, fArms choose k1 so that the expected net marginal
product of capital equals the world interest rate, vIUfk(kl,1) = p +
g
This leads to k1 = vLm/p+&)1lU. After v rises to v' in period 1,
however, the capital stock rust remain fixed at k1 even though the the
capital stock desired for period 2 rises. Net investment in period 1,
equal to k2 —
k1, is ther efore gi yen by
= [u/p+S] 1/1—u Nv' — it) >
o.
Investment in all futur e periods is negative (when 7..
7..
= 1)
if
< 1)
or zero (when
there are no further shock s. 4ccordinq to (14) and 17C
time path of investment from period 2 on is
S-i.
C,
= 1/F 31! 1[
Fiqure 2
j)t1 )
0
3
(t 2>.
illut rates the response of domestic investment to a temporary
productivity in crease.
What abou t the behavior of national savi
ng? First—period consump—
tion jumps to a level fully incor porating the
information embodied in
(35)
while
(as no ted earlier) remains at I
ts predetermined level.
Period I savin g S1 is therefore eq ual to w1 +
(q1 + d1 — q0)h0 + pb0
C1,
or,
(36> S
using
1'iA
—
26> and (28)
= (1/I+p)((w1
= (lf1+p){tw1 —
+
if
pZ.1(1+p)
w j+1
3
+ (pfl[(v'/i> 1-a_1
)k1h0)
is the component of saving due to
deviations between the current real wage and the discount—rate weighted
average of future wages. When the current wage exceeds the permanenU
wage, for example, househ olds will tend to accumulate wealth in order
to
smooth their consu mpt ion over time. The second term in the braces in
(36) reflects the wi ndfal 1 gain to stockholders caused by a temporar
y
deviation between the net marginal product of capital and the world
of return p. Becau se
c annot
rate
be adjusted until period 2, an unan-
ticipated producti vity sh ock in period 1 leads to a deviation from the
Perfect—foresight arbi tra ge condition (22). The resulting abnormal
profits are expected to disappear next period, so only a fraction p/1+p
of the windfall is consumed in period 1.
To understand the response of aggregate saving, it is useful to
consider each of the terms in (36) separately. The effect on saving of
temporarily abnormal profits is
It
0
Time
1
Figure 2
nitude is independent of the persistence parameter . Equation 3O)
shows that thi s effect is given by (1 /1 +p) (p+V ((Ku'
1/ l+p)utalpfl
However
a/i—a
(1—a) a —
(Ku')
v
/
1 01] K h.)
1 0
v) )h0.
the persistence parameter ?\ plays a key role in determin—
ing the impact of wage movements on saving. When ?
so that the
1,
productivity s hock is permanent3 the period —i wage rise s to the level
1-a) (VI) iska =
(1—a)(u/p4t]
a/i—a
Ku')
shock wage and the wage (1—m)(a/p+f]
i—a a
V
a/I—a
which lies between the pre—
V1 expect ed to prevail in all
future periods (see equation (31)]. Since t he wage in p eriod 1 is there—
fore below its permanent level, the +irst t arm in (36
equal to (1/1+ p) K 1-a) (a/pH 3a11-a1
(1) V a
—
V'
is negative and
If
h.U = 1,
all shares in the domestic +irm are domestically owned, net
saving when
=1
so that
first—period
is
=
Ku')
1—u u —
(l—u)v' —
v
mu],
a neoati ye (and probably small) n
K 1;
if
and saving is zero from p eriod 2 on (see (33)]. If the only
shocks h itting the economy are pr oductivity shocks which are perceived
as perea nent, the time—series cor relation between saving and investment
changes is likely to be negigible
In
the general case the t ime path of saving is
SI =
(i/1+P)(a/P+vJlaccl_(i_h0)Dac(VI
a / 1—a
St
(I/l+p)la/p+f]
(u' —
lmua_V]_(l_a) EpXJ (l+p-) i v '
v)I(1 )ytl/Ki+px)] > U
enouch (so that the disturbance is sufficiently transitory),
(t
-v))1
2),
may now
be positive. Since wages are expected to decline over time, the increase
2 —
in w oer w
1
may be sufficiently larqe to induce savino even though w
(I
is lower than it would have been if the firm had correctly foreseen the
d 0. Fgur e 3 depicts a saving
per iod—1 prod uctivity i ncrease in p er
i 0
pat h in which first—per iod saving i S
p0 sitive. Th is may occur even if
all shares ar e owned by foreigners
in h
h0
0), alth ouqh
is increasing
0
Figures 2 and 3 t ogether make the point that investment and saving
innovations can be posi tively correlated when both are c aused by tern—
porary shifts in the domest
tivity alter saving as
i C
well
production function. Shift 5
in
produc—
as investment incentives by conferring a
windfall gain or loss 0 n domes tic shareholders and chan ging the path of
real wages. When shock s to the prod uction function are sufficently
transient, saving and
i nve stment
Wi 11 move together in the short run.
The purpose of t his section h as been to provide a single illustra—
tive example, but it i s ci ear that factors other than productivity
shocks can induce a po siti ye conrei ation between savin g and investment
innovations. Suppose, for example, that production req uires as an input
an imported good that is d istinct from t he output of t he domestic firm.
If imports and capital ar e complements i n production, a temporary fall
in the relative price of imports will sp ur investment and also encourage
saving as households spre ad the temporar y increase in their real incomes
over all future pen ods. Temporary chang es in the won d interest rate p
(the intertemporal terms of trade) also cause simultaneous movements in
saving and investment.21
V.
Nati onal
A Proble. with National Income Account Data
income account (NIA) data provide notoriously poor
proxies for th e economic concepts of saving and investment. For example,
St
0
1
2
3
4
Figure 3
Time
—3(1-
purchase-s o consumer durables, which really represent investment, are
treated in the accounts as current consumption. Since national product
figures represent the nominal val ue of goods and
ser vi
ces produced by a
countrys factors, as measured by real ned finan cial 11 ows, exchange—
rate induced redistrib utions of w eal
between n at ions do n ot enter into
th
the NIA definition of national in come or saving. Also i gnor ed are the
chanoes in the real va lue of net
ext e r
nal debts due to
i nfl
ation [see,
for example, Freedman (1979)3.
The previous sec tions theo retical model suggests an additional
data problem which is related to those associated with
price—level variation. This prob 1mm is most acute for
mx ch ange—rate
ec ono ohms
and
in which
a substantial share of domestic industry is forei gn owned, or in which
much of domestic wealt h is held as shares in fore ign firms.
In the
former case, that in whi ch forei gners own domesti c shares, the correla—
tion between the NIA mea sure of saving and invest ment will tend to be
higher than that between the tru e value of saving and investaent.
Continue to assume ther e is no government, as in section IV, and
recall the definition of net saving i n that secti ons model [equation
f7
ti—
St
- cit tt i +
wt + (cit 4
— Ct.
The defini tion of dividends dt and the fact that q
=
(28)) impl y that aggregate net saving may be writt en as
(37) St =
Since q +
equals net
t i on.
—
Vt
lkt
—
+ dt — q t-i 1(1 —
=
+
( k
,
1)
k
—
h
ti
) +
— Ct.
(37) states that net saving
output plus net factor payments from abroad minus consump—
In contrast to (37) the NI definition of net sav1n. N1St,
iqnores the capital ains on foreiqn securities accounted for by (37)
and instead sets
(38) NIASt =
yt — •kt
—
( t 4 d th ti
The second line of
+ pbtj
dt(i—ht
+
pb1
— c ) +
t
— Ct
(: t+l
—
t
(38) shows that NIS i s the sum of two components,
the NIA concept of personal saving (which also ignores
plus what
is usual ly
capital
gains)
defined as corporate savi ng, i.e., retained earn—
ings. Regrouping t he terms on the second line of (8) shows that in the
model of section IV,
(39) N14S =
S
+
(l_hti)
— kt)
itplying that the NIA definition of saving equals actual saving plus a
term proportional
when h
1,
to net
investment.
so that all shares are domestical ly ow ned,the NIA
concept of saving and true saving coincide in this model
The reason is
that corporate sa ving just equals the increase in th e firm s ex—dividend
market value, so that when no shares are owned by fo rei gne rs, the addi—
tion of corporate saving to personal saving corrects the 1 atter measure
for the omission of capi tal gains from personal moo me. Bu t when h < 1,
the addition of c orporate s aving to personal saving
i
nfl at es
aggregate
savi ng by i ncorrectl y counting as part of domestic i ncome
capital gains
that
actual ly accrue to foreigners. The error equals
the
f
raction of
fore 1 gn—own ed shares tImes the firms net investment
Equat ion (39) m akes clear that NIA convent ions
may art f
id
ally
Increase th cor relation betweer measured nation al saving an d domestic
investment. Fara doxically, the magnitude of this distortion is
greater
the larger the share o4 domestic firms owned by foreigners, that is, the
more open is t he economy to foreign portfolio investment. lndeed, in an
integrated wor ld economy with full international portfolio diversifica—
tion, we would ex pect domestic residents to own a negligible share of
the domestic f irm when human—capital risk is approximately uncorrelated
with the fir m s profitability. But if h
0, national income data for
the economy o+ section IV would nonetheless show NIA net saving and
investment as being perfectly correlated precisely when investment is
totally un correlated with the economically relevant measure of saving.
The prevalence of earnings retention as a means of financing
corporate investment lends empirical significance to this problem.
2
But
the magnitude of the errors involved is unknown. Gross capital flows
between countries are very large even though net flows, as measured by
current account imbalances, have been small (see section Ill). So while
the problem may be of minor importance for the U.S., where the ratio of
foreign—owned capital to total capital is low, it may be of greater
importance in other economies. It should also be remembered that in
reality, NIA saving differs from true saving not only because of capital
gains on foreign—owned shares but because of unobserved capital gains on
foreign shares owned by domestic residents. The effect of this additional discrepancy on the correlation between NIA saving and investment
is theoretically ambiguous.
VI. Saving and Investment in the Short Run:
Time—Series Evidence
This section presents estimated correlatio ns between quarterly
changes in saving and investment rates, for seve n UECD countries, over
the period since the restoration o4 currency convertibility in late
1958. Confidence intervals for tnese estimates a re also calculated. Ihe
enpiricJ r&sults are consistent wit h a significant and increasing
decree
o{ capital mobility
There
are
over the sample period.
least four reaso ns why short—run time—series correla—
at
tion coefficients between changes i n saving and investment rates are of
interest. First, and mo st important ¶
they provide a set of empirical
recularites with whmch theoreti cal open—economy models must be consis—
tent. These empir ical r egularities a iso suggest hypotheses that may
inspire more powe rful t ests in the f uture. Second, estimation of the
coefficients and their asymptotic di stributions permits an assessment of
the significance of the ir difference from the value of 1 that would
obtain under comp lete c apital immobi lity. Third, the results can provide
scce guidance on the ap propr i ateness of pooling time—series observations
on different cour tries, as in Feldst em
strong mdi cation
(1983). In fact, the data give a
that such pooling is not appropriate. Fourth, even
though (as was sh own in section IV) short—run saving and investment
changes need not be unco rrelated und er perfect capital mobility,
measures of thei r
the forces that
correl ation are likely to be unaffected by some of the
may limi t prot racted current—account imbalances over
longer periods. This is still insufficient to allow rigorous inference
concerning a
countr y' 5
opennes s to capital movements. But once the
saving and in vest me nt rate dat a have been purged of movements caused by
known common
factor s,
such as effective labor—force growth, the iden—
tifying assum pt ions needed to permit such inference become more
plausible. Of
tion of some
cours e, addition ml tests may ultimately lead to the rejec—
or all
of these i dentfying assumptions.
The dat a used in estimat ing the correlations a re nomin al quarterly
national—account data from the International Monetary Fund's Inter na—
tional Financial Statistics data tape. The sample of countries was
—34—
dictated by the availability of quarterly data over a reasonably long
sanp 1 e
per iod; it cons sts of Austr all a
, Atistri a,
Republ 1
Co +
K i
For
the
at t e mp
t
Berma ny, Japan
sa ke
the Uni ted
no
Canada, the Federal
and the Un i
d a
ted
States.
24
of c omparabi 1 ity with the Fel dstei n—horjoka r esul ts, no
the data
wa s made to adjust
to account for any of the potential
problem s discussed in secti on V. In ad dition, gross rather than net
saving and investment sen e s were u t il i:ed. Saving S was defined as
gross n ational produc t (GNF
consump tion.
minus p ri vate plus go verneent
Invest ment I was def in ed as g ross fixed capital f ormati on
plu.s the change in st ocks. The corr e ations that were computed w ere
between t(S/GNP) and
t.(
I /ON P),
wher e L denot es a quarterly first dif—
ference. The populati on val ue of th is correl ation will be labell ed
p.
Obtaining point est imates of the cont empor aneou s correlati ons p51
presents no difficulties. Under conditions spelled ou t in Fuller
(1976)1
of the ts(S/ GNP) and
chapter 6, which imply joi nt covariance sta ti
onar i ty
A(I/GNP) series, the sampl e correlations
provide consi stent es-
timates of the population correlations p51.
Statisti cal inferenc e based on the est i
mat ed
an asymptotic distribution theory, however.
Ass LI
a(IIGNP) series are jointl y normal, let Sl
j)
=
correlations requires
me that the MSIGNF) and
m15(—j) denote the
and let
unconditional populati on covar 1 ance Coy E s (SIGN F
c1 L) denote the corresp onding sample covar ian
observations. Denote the popul a tion aut ocovar
= Var [a
and m11(j); of cou rse, 0
Var[t(l/GNP)], and p51 =
functions
o{
£1
(0)
I
0 11
ce based on a sample of T
i a nces
for the series by
(S/ GNPU,
( 0
=
1. If the autocovariance
the two series are absolutely summable, then
(40) liST.ll Vartc51 (0)) Z r5(J)r11 Li) +
Ej_SJ (J)c15(j)
M
—35.-
[Fuller
(T[Cç1
(197) theorem 6.5. 13. It can be shown that the random variable
(0
—
(0)3 has a limiting normal distribution with mean 0 and
variance equal
(41) JT(rj —
to Fl tHannan 1970), theorem 143 chapter iV). Therefore
p1
in distribution. From (41), th asymptotic standard error c-f r51 is just
(42) M/To.s (0i i(0)3.
The variances
and a11(0) in (42) can be consistently es-
timated by sample variances. It is
tently ir
also possible to estimate M consis-
the time domain by truncating the infinite sums in (40) at
as j that
increases sufficiently quickly with sample size and sub-
stituting sample covarlances for their population counterparts. However3
S.in;letun (19601 and Hodrick and Srivastava (1965) have suggested a
frequency—domjrT procedure for estimating Fl
that is more convenient from
a computational point of view. That procedure is implemented in
obtain-
ing the standard error estimates reported below.
Define the autocovariance matrix
r61 (j)
(43)
m(j)
=
°Is 0(J)
Then the spectral density matrix for the vector
process
at frequency i
(44)
sk)
is
given by
(1121T) E '(u)e'
11
where i
j-i.
Direct computation using c43) and (44) shows that N can
be written in the form
(45) N =
2111 ssii
+
(V3du.
Consistent estimates of the spectral density matrix s() may be used in
"6
formula (45) to obtain a consistent estimate of M/
The results, for the entire sample available since the return to
convertibility, are presented in table 1.
A pronounced pattern emerges from these estimates. For the smallest countries, Australia and Austria, the contemporaneous correlation
between t(SI6NF) and t(lIGNF) is low. In the case of Austria, r51 is
statistically insignificant. For Canada, Germany, and the United
Kingdom, the correlation coefficients are statistically significant but
lower than the cross—sectional coefficients reported in the Feldstein—
Horioka papers. Dn]y in the cases of Japan and the United States, with
r51 values of 0.846 and 0.908 respectively, are the correlations of the
same order of magnitude as the coefficients estimated by Feldstein and
Horiok'a. Also, it is only in the cases of Japan and the U.S. that the
estimated coefficients do not differ significantly from I, the theoretical value under complete capital immobility. However, the U.S. is the
largest country in the world economy, while Japan has had extensive
capital—account controls until very recently.
The results of table 1 therefore suggest that the measured saving—
investment correlation is an increasing function of country size. Except
where capital controls were an important factor, the correlation is low
for small countries, moderate for medium—sized countries, and high for
the largest country. Harberger (1980) and Murphy (1984) have argued that
the link between saving and investment will increase with country size
Table 1
Estimated Correlations between Chanqes in Saving and Investment Rates
(Quarterly Data)
Country
Sample Period
Australia
60:! —
83:Iv
0.194
0.106
Austria
70:11 — 84.1
0.13:
0.195
Canada
59:! — 84:11
0.550
0.125
Lermany
60:111 — 84:11
0.649
0.133
Japan
59:1 —
83:IV
0.846
0.140
United Kingdom
59:1 — 84:11
0.604
0.166
United States
59:1 — 84:11
0.908
0.143
Standard Error
because a ccurt'7
h or wor I
at
certainly
C
in world
prices prows a; its share
ci
pro sented
tiectes
to influence the world interest rate and
ati I itv
anrot
output prows. The es-
inter pretati
on, and
be i ruterpreted as cv idence aoainst p erfect
capi tal
with
here are consistent
this
ndsed, the evidence is ful lv consistent wi th a world in which
tI!L!.I .1
capital
mob
iiity
is substantial, but
in
which saving and investm ent
changes can be significantly correlat ed for reasons 1 ike those d i scussed
in section
1V and because of country si Se
27
IL 1 s interesting to compare th C results of table 1 to a pooled
t I me —5cr i e s cross—section regression
n Feldstein (1983), p. 136, which
1
correl ates year—to—year changes in th e
rate with year—to—year
i n vest men t
changes in the saving rate. The slope coefficient in that regression is
0.Bt3
I!
(wit h
a standard error of 0.040)
from whic h it is concluded that
even year to year increases in saving tend to be associated with in-
creases
in
domestic investment in the saving coun t ry by approximately
Equal amou nts.h The evicence in table 1 shows tha t on a quarterly basis
trere is c onsiderable heterogeneity a cross coLntr en with respect to the
u niformity
e;ontud e o this association. The as sumptior of
the pool ing procedure is therefore im p
t er pro
of
t the reported standaru error of estimat i
the s c'
ia -cnrrelati or properties
is also ciifficult to
It
1 a us i b 1 e.
implicit in
without a discussion
on
of the regr ess ion s error terms.
S nce the br eel down of the post war systeit nc f.!ed e;change rates
n l57
there has been an apparent i ncrease ic
t he
integration of world
capital earl ets. Four set; of reasons are us u a 11 y given 4or this
cieeloprrent. The first involves the di scant I
nier' tc cap;tai cavernart
t
ing
hat had impeded i nt er
un:or fi:ed ecchar.po rates ciL t appearec' super f
of
r a
1 u o u
the wioespread bar—
tional money flows
s under f Icr ible
rat Ci. The second certer s on the emergence of the OPEC surpluses after
art tho
orowtb c{ world trade generally, develoornents that raisEc
ounaro for the services of i nt 5 r fl a t
i
C' P a I
4
inanc al :nterseciaries.
T he
third set of reasons is related to technological chanqa jr the corn
muni cat I UPS and dat a—processi nq areas. The fourth crc-c ems I ncr e a 5 ed
multinatcnai corporate activit 28
These considerations suggest that the
stochastic propert ies of the
saving-investment process may have changed over time. To
inves ti gate
this possibility the samples were split at 1972:IV and the cor rd ati on
coeHiclents were estimated separately over the sub—samples.
The pr oce—
dure was not carried out for hustri.a because the data on that countr y
are available only from 1970.) Table 2 reports the results. jr all c ames
except that of 4ustralia, r51 drops——sometimes dramatically——be t
ween
the
earlier and later periods. This evidence is consistent with the
widespread belief that the decree of international capital mobility
increased after 1972:IV. Note that for the second sub—sample
r51 reman-s
more than two standard deviations below I for all countries other than
Japan and the U.S. But once again, the high estimated correlations for
these two countries can be ascribed to capital controls in the Japanese
case and country Size in the U.S. case. Because the estimated correlations are higher before 1973: I and because smaller sample size results
in less precise estimates, r51 lies within two standart errors of 1 more
frequently in the first sub—sample than over the complete sanple.
One further test can be conducted to help evaluate the argument
that high values of r01 for the United States are a consequence of its
size rather than capital i mmouil i ty. The Uni ted F ingdom occupied a
similarly dominant position in the world economy during the pre—Worid
War I gold-standard era, particularly from 1870 onward, and its experience then is often cited as the
o
Table 2
Estimated Savinu—Investeent Correlations up to and after 197:IV
(Quarterly Data)
after 72:IV
Country
r51 up to 72:IV
Australia
0.095
(0.147)
0.331
(0.155)
Canada
0.716
(0.193)
0.399
(0.143)
Germany
0.747
(0.198)
0.536
(0.168)
Japan
0.885
(0.184)
0.723
(0.190)
United Kingdom
0.622
(0.196)
0.593
(0.235)
United States
0.962
(0.191)
0.870
(0.207)
Note: Standard errors appear in parentheses.
ccrreiaton
hc.t
ecbiIit.
rent ratec c\Er
between changes in U.h. savinQ and invest—
the Qoib—standard
direct evidence that the U.S. results are consistent with substantial
ta It1cti ii ty.'
Ua1 data
Eel nstein
+rcIL
19
error
d rqj and its asymptotic standard error were calcu—
he estimate d correlation c oelficient is 0.722, with a standard
I
an
of C: 199. Thi
U.S. over t he
those
coefficient s not quite as high as that for the
1
float in g
repor ted
of
r5 for
the
from 1, in 5 pite of the
period. it follows
that
of
the high value
capit a! move gi en t.
t ha t
tent with substant 1 al
4 r o m
undeniable mobility
post wa r U.S. prcvi
The picture
ntrIe5
period, but it exceeds many of
In addition, the coefficent does not
1 and 2.
dur ing the go 1 d—standard
inter neti 0 nal
0 0U
enchanqe ra te
n t ab les
d1+er sign i+ i cant! y
capital
table 2. Say
•
the post war tests,
lated.
the U.k. coverinfl the period 1871—1912 were taken
+ or
In most
emerges
and increasing capital
cases
the value of
from t hese time
series
tests
mobility among OECD
saving—investment correlations are qu ite
impl ied by complete cap ital immobility.
are
not, high corr ci at i 0
+ C: t
S or to Cnown
is consis—
can be asc ribed ei ther
to
Wh
far
en they
large—coun try ef—
off ic al restricti ons on i nternational
asset
trade.
VII. Con clusi ens
Cap tal
ing
mobility i n the wor ld
asset yiel ds
economy h as been measured by compar—
across count r l es an d, more r ecently,
comovements be tween
savi ng and in vest
duced by Eeldstein and Horioka (198:0)
encounter se.ere
considorahie
identification
merit
probl
.
and by
by studying
e sec
Felds tein (1983),
may
the
of focusino attention directly
on the determinants of
intertesporal trade patterns.
E:oth international interest—rate data and data on national saving
and investment patterns are consistent with a world in which capi tal
mobility is substantial, at least amon g OECD
countr ies.
In p articular
quarterly time—series correlations bet ween changes in saving rates an d
changes in investment rates are in mos t cases signi ficantly distant 4 r
om
the value of 1 that would prevail were capital enti rely imm obile ac r o cc
national boundaries. The data are also consistent w ith the hypothes s
that capital mobility has increased in recent years • Future researc h
should aim to sharpen our knowledge by explai ning both the
t i me—ser i es
correlations reported above and the cross—sectional correlations em—
phasized in the Feldstein—Horioka studies.
Notes
I thank Michael W. Klein for excellent research assistance and sugges—
tions. Helpful co mments were made by Robert Cumb y,
Michael
Edeistein,
Alberto Giovannin i, Robert Hodric k, Philippe Jor ion, Laurence Kotlikoff,
Allan Meltzer, Fr ederic Mishkin, Kenneth Singlet on, Rene Stul:, and
Lawrence Summers. All errors and opinions are my own responsibility.
Financial support was provided by grants from th e National Science
Foundation and th e Alfred F. Sloa n Foundation.
1. The synchronized nature of the rise in world real in terest rates is
documented, for various
Elanchard and Summers
me a sure s
of expected domestic i nflation, by
1984) and by Cumby and Mishkin
1985)
2. As noted by Kotlikoff (1984), there are special circumstances (such
as those assumed in the static Heckscher—Ohlin trade model), in which
—41—
the international allocation of a given stock of productie factors can
be efficient e yen in the absence of capi tal mobil
i ty.
Ohlin model! t his occurs when no country is speci
ali z ed
In the HecIscher—
in production,
so that factor prices are equal everywhe re. But w her
capital is immobi—
le, factor—pri ce equali:ation at a point in time doe s not imply that the
world allocati on of resources is interte mporal I y
dynamic Hecksc her—Ohlin models may entai
1
ef f
icient. In addition,
optimal ca pi tal —accumul ati on
paths leading to a steady state in which one of t he countries is spe—
ciali:ed (or b oth are) and factor prices differ i nte
rnationally.
3. Some policy implications o + th is Ii ne of empi r
non
discussed in Obstfeld ( At TOt
i cal
research are
Pro blems con nec ted with the taxation of
interest paym ents remai n rel evant even when the group of assets studied
is narrowed; see Howard and Johns on (1 982,1983).
4. Similar analyses appear in Hansen and Hodrick
(1983), Hodrick and
Sri vast ava
(1984
Svensson (1 984).
•
•£700
nor
Stul z
Kouri
/ 'TOO
Inn-v
Lucas (1982), and Stockman and
(1984) p rovi d es a useful survey of the theory of
asset prici ng fr om an internati onal perspective.
5. In models with cash —in—advance constraint
5,
(1)
and (2) will not hold
in general if nominal consumption expendi tur es cannot be predicted with
certainty a p eriod in advance. St ockman and Svensson (1984) analyze a
model of that type. I n contrast,
(1) and (2) always hold in Lucass
(1982) cash—i n— ad vanc e model . Eec ause the pr esent discussion is il—
lustrative, I make no attempt to motivate th e existence of national
mon i e 5.
— 42—
6. Uncovered interest parity follows from (3. if
the marqinal consump—
tion value of domestic currency is distributed independently of the
exchange rate. While it is d ifficult to assess this possibility in the
present, partial—equilibrium setting
general— equilibrium model s of
Lucas (19 82) and Stockman an d Svenss on (1984) suggest that (4) is Un—
likely to hold when there ar P outpL't shocks or domestic moneta ry shocks.
Hansen and H odric k (1983) sh ow that (3) leads to a log—linear
tion to (4)
i nvol ving
a time —i
nvar i
ant risk pr emium when all
variables ar e joi ntly lognor mally d istri buted.
empirically.
)
If
agents are risk ne utral
,
(4)
a p pro x i
ma —
rel evant
(They reject t his model
h olds
if the pr ice level
and exchange rate are indep endently distributed [see Engel (1 984) and
Frenkel and Rn in (1980)). The assum ption of ri sk neutrality may have
implausible conse quences in general equilibniu it
however. If the instan—
taneous util ity f unction is linear and the same in each pen od, for
example, mar ginal rates of substitution in consumption, and hence the
terms of trade, must be fi xed.
7. There i 5 relat ively I ittle empirical work that attempts to model the
risk premi urn expl icitly. Hansen and Hodrick
1983)
test, and reject,
some simpl e model s of mt ertemporal equilibri urn (s ee the previous
footnote).
Fr an ke 1
(1982)
is unable to reject a tw 0—period mean—variance
model based on a portfol i o of six currencies. Hodr ick and Erivastava
(1984,1985) discuss emprical aspects of Lucas '5 (1 982) model.
8. The argument made above to justify ignoring default risk on Eurocur—
rency deposits is inapplicable here because the deposits being compared
are not issued by a single bank. Even when there is no currency
r i s k
nominal interest rates can therefore differ across national boundaries.
L
However
he detec ted an increase in potenti
al arbitrage profits over
the period freT the end
of
1980 to early 1982.
part to inc reased co
their requl a
1 0
the part of banks and
r s.
Frank el (1984) discusses recent measures
opening Japanese capital
mar kets ¶
6i a
t 0
He attributes this in
van
i
spr eads
and also presents evidence on interest differentials
—
i
both the
Fagano and Ito papers, like Kreicher's, account for bid—ask
n calculating potential arbitrage profits. Ito also accounts
for domes tic transaction taxes.
11. Since
ng, a
correl ati on coefficient,
there is no reason for it to be less than
This is b orne out by the
simulated regressions reported later in this
section.
In what follows I sometimes refer to
as a "correlation,
II
but
it should be understood that
12. Feldstein and Horioka (1980) also present instrumental—variable
estimates based on an explicit model of aggregate saving. They
regard
those results as supporting the conclusions reached earlier in their
paper. Howeve r, interpreting (8) as a structural investment equation
involves some potential specification errors. A number of studies
have
pursued the a pproach outlined in the text. Penati and Dooley (1984)
and
Fieleke (1982
obtain results consistent with those reported by
Feldstein and Horioka. Capric and Howard (1984) find that the
results
are quite sen sitive to the period over which saving and investment
rates
are averaged, while Summers (1985) finds that the correlation
between
saving and investment rates falls dramatically when
less—developed
—44--
cc'untrieE arE included in thE sample. Eachs (1961,1953) carries out
cross—sectional regress i on;
c h n p es
in domest ic
1 n Vol Vi n p
investment
in apparent
current accounts,
findings of 1 I cited
capital
G4i and 1/Y, concludina that
have ha d large, negative effects on OECD
contradi ction of
mo bi
1 ity.
However
the Feldstei n—Hon o ka
Sachss empirical r esul
ts
are subject t o the difficultie s of mt erpretati on outlined below i n
connection wi th the Feldstein— Hor i
oka
findings. On the basis of an
empirical sim ultane ous—equat i o n model of saving and investment, von
Furstenberg
19 B 0)
i n tern at i on a 1
by
capi t al
(lime (197 7),
on fiscal def i
concludes t hat the United St ates is quite open to
movement
Anothe r relate d approach is that taken
wh o performs time— ser ies regr essions of trade balances
cits
for a large sample of count ries. Seve ral papers in
the development literature att empt to measure the impact of capital
inflow on saving and investment by regressing those variables on the
current account. Leff and Sato (1954) discuss some econometric bi ases
that may arise.
13. Fel dstein and Horioka (1950) recognize the potential importance of
common factors affecting both saving and investment, but assert (p. 319)
that th eir strong results place 'the burden of identifying such common
causal factors' on proponents of the hypothesis that capital is interna
ti onal I y
mobile. The demonstration in this section that equally strong
results can emerge in a world with perfect capital mobility hopefully
redi str ibutes the burden more equitably. The empirical relevance of the
forces driving this sections simulation example is discussed below.
Summers (1955) points out that least—squares estimates of
do not
measure the effect of aggreqate saving on investment when fiscal policy
systematically counteracts shifts in private spending. The theoretical
At
-'U--
possihiljt that
exceeds 1, not ed
Interpretation of this coefficient as
saving that is ref1ectej
above,
seems inconsistent with
the fraction
of any
tb
increase in
ic investment.
14. Buiter 19B1) has studied a two—coLintry version of
the
model
employed here.
effect in the
model. I concentrate here (and in the theoretical model of section IV)
on net saving and investment, rather than on the gross concepts em—
phasized by Feldstein and Horioka (1980) and Feldstein (1983), because
net concepts are the economically meaningful ones. s
remarked above,
those authors found even higher correlations between saving and invest—
,.ent ratios constructed from net measures. They ascri bed the higher
correlation to a common
lb. 6rowth rates g were taken to be average annual real 6DF growth rates
over 1970—1979, as reported in the United Nations Statistical
book, 1981, table 30. (The GDP growth rate for New Zealand was calculated from data reported in the International Monetary Funds
tional Financial Statistics.) Labors sharp, 1—e, was calculated as the
ratio of employee compensation to national income in 1970. These data
were taken from OECD, National ccounts of OECD Countries, vol. II,
1974. No attempt was made to correct for the labor income of the self—
employed, so the estimate of 1—u used is an underestimate of labors
s h are
the
This b ias reduces saving rates relative to investment
rates in
S mul ated economy.
—46-
17. One alternative explanation involves the economys intertemporal
budget constraint, which states that
to the change in the economy s n et
current accounts must sum over time
external assets. 1+ there is a ten-
dency for the economys external assets to approach some steady—state
level, as a result of residents
consumption preferences [as in Obstfeld
(1981)] or of the pattern of sho cks disturbing the economy, saving and
investment will necessarily tend toward equality over long periods.
Features of the tax system simul taneously affecting saving and invest—
ment
rates could also be
part of an explanation.
18. For example, German ys current account balance in 1982 was DPi 6.6
billion
but it ran a b ilateral current—account surplus of
DPi
14.7
billion against France alone in that year. In all of the three years
1979—19 61, Ger&any ran historically large current—accoun t deficits, yet
it was a net lender to France and other countries. [See Deutsche Eundes—
bank (1 963).] This typ e of current—account behavior is inconsi stent with
the ide a that overall current—account imbalances are lieited by con—
siderat ions of soverei gn—risk exposure. I am indebted to Larry kotlikof+
for thi s observation.
19. Stockean and Svensson (1984) analyc e a stochastic two—country
monetary model in which the investment decision in one of the countries
is explicitly modelled. They also find that saving and investment may be
positively correlated, but the mechani sas operating
in
their model stern
from terms—of—trade effects and are di fferent from the one emphasized
here.
20. Taken literally, this assumption may require that dividends be
—4—-
roati\c. i1 sour periods. I he possibility of
negative dividends raises
no conceptual difficulties, but for the sake of realism one might want
to assume that shocks to te chnology, and henc
e period—to—period changes
in the capital stock, are" seal
21. Persoor, an d Even eson (19B5
to study the e f
I
fec t s
1
use an overlapping—oenerations framework
of various terms—of—trade shocks on saving and
n vest men t
22. The pr oblern is al so discussed by Stocksan
and Svensson (1984), who
show how I t distorts reported current—account data.
be modified if the firm financed some investment
through debt issue. In this case the difference betweem NIAS
and S would
be proportional to net investment mi nus corporate borrowing.
The problem
does not arise here wh en investment is financed exclusively
through the
issuance of new shares
24. These data, with t he exception of the Austrian data, were available
only in seasonally—adj usted form. The estimates for Austria
reported
below
based
theoreti cally preferable seasonally—unadjusted
data.
25. in
the U.S. data,
the government consumption variable includes
government investment. This is not the case for the other
countries,
whose nati oral —income
data are compiled according to the United Nations
System of National 4cc ou
n t s.
-48-
26. Formula
(45)
appears in Fisnean (1969), p. 1 21. In the present
application, the spectral density matri> was est imated at T equally
spaced frequencies bet wee
n
—s and 11,
where I is the number of observa—
tions. Atriangula r mm ooth ing window of width me yen was used. An es—
timate of Ii was th en c a
1 cu
lated by summing the i ntegrand in (45) over
'1
the I frequencies
inult iplying
ar.d
the result by
27. Bummers (1985) per for ms a cr oss—sec t
including sm
all,
1
ems —d cv eloped
countries in ci uded in the
parameter
is only
-
Fe 1 d st
-7
I arge—countr y effect s are
i ona I
count r i em
4u'/T.
regression on a sample
in addition to the UECD
ei n—Nor ioka
studies. His estimate of the
This evidence lends support to the view that
in
part respons ible for the Feldstein—Nor
i o ha
findings.
28. Bryant (1985) reviews the postwar growth of international financial
intermediation.
29. Between 1870 and 1913, LI.I.. net foreign lending averaged 5.2 percent
of ONE
•
a figure that is enormous by postwar standards (Edel stein
1962. I. The temptation to quote Keyness description of the per iod is
i r r em i
stible: The inhabitant of London could order by tel
ping h is morning tea in bed, the various products of the
eph one
w h ol
ee arth
and in such quantity am he might see fit, and reasonably eKpe ct the r
ear I y
delivery upon his doorstep', he could at the same mo
me n t
an d by the
same means adventure his wealth in the natural resources and new en-
terp rises
e v e n
of any quarter of the world, and share, w:thou t cxc rti on or
trouble, in their prospective fruits and advantages; or he could
decide to couple the security of hs fortunes with the good faith of the
- townspeople of
or informatiw, might recommend. He could secure 1orthwith if he wished
it, cheap and Comfortable means
o
transit to any country or climate
without passport or other forsality, cCuld desatch his servant to the
neighbouring office of a bank for such supply of the precious metals as
might seem con'enient. and could then proceed abroad to foreign Quarters, without knowledge of their religion,
language, or customs, bearing
coined wealth upon hi person, and would consider himself greatly aggrieved and much surprised at the least Interference. But, most Important of all, he regarded this state of affairs
permanent, except in the direction of further
as normal, certa n, and
improvement, and any
deviation from it as aberrant, scandalous, and avoidable.
(1919),
C Keynes
9—10.]
References
P4liber, R.Z.
(1973)
The Interest Rate Parity Theorem:
Journal of Political Economy, 81:
Reinterpretation.
1451—1459.
Blarchard, 0. J. and Summers, L.H.
(1 984)
Perspectives on High World Real Interest Rates.
Brookings Papers on Economic ctivity, 15:
273—324.
Bryant, R.C.
(1985) International
Fi
Impi icat ions for
Inst i tut ion,
nancial Intermediation: Underlying Trends arid
Government Policies. Mimeographed.
Wash ington, D.C.
Brooking;
—C,,-
Eluiter. W.H.
1c
lime Ereferene and international Ld1r! and E:orrowinc in
an Overlappinq—Generatiors Model.
Economy. 69:
Journal of
Folitical
765-797.
Caprio, 6.., Jr. arid Howard, D.H.
1984)
Domestic Saving, Current Accounts, and International Capital
Mobility. Intern atinnal Finance Discussion Papers no. 244,
Board of Bcvernor s of thE Federal RCSErvC System.
Cumby, R.E. a rid
(1985)
Mishkin, F.S.
The internati onal Linkage of Fel Interest Rates: The
European—U. S.
Journal of International
Connection.
Money and Fin ance, 4: fort h
c o m i n g.
Cumby, R.E. and Obstfeid, M.
1981
6 Note on Lx chanQe—Rate Expectations and Noninal
D i1fererital
Finance, 36:
Test of
the
Fisher
H y p0th es 1
5.
1 ri
t er C S t
Journal of
697—704.
Cumby, R.E. and Obstf mid, M.
(1984
lnternatonal Irite rest
Rate and F'ric Level Lin:aoes under
Flexible Exchange Rates: A Review
of Recent EVI dence. Ex chanoe
Rate Theory and Fr actice. 3.F.Q. Bilsor and R.C. Marstor, eds.
Chicago: Uni versi t y of Chicaqo Press.
Deutsche Burdesban
1963.i
Ire Ei ance of Fayment of
the Federal
Fepubi ii of Cermanv wi tt
—51 —
1l
Countre 4rorn 1970 to 1982 and with Individual Groups o4
Ccuntrie and Countries +roff 1979 to 1982. Appendix to
Monthly
ports o the Deutsche Eundesbank, Series 3, no. 7, July.
Lcoley, NP. and Ird, F.
(1980 Capital Controls, P1itica1 Risk, and Deviations from Interest—
Rate Parity. Journal of Political Economy,
370—384.
Ede1tj, N.
(1982) Overseas Investment
in the Age of High Imperialism: The United
irigdom,185fl—1914 New York: Columbia University Press.
Engel ,
C.P1.
(19B4) Ietin for the Absence of Expected Real Profits from Forward
Market Speculation. Journal of nternatjona1 Economics, 17:
299-30B.
Feinstein, C.H.
1972) National Income, Expenditure and Output of the United Kingdom,
1855-1965. Cambridge: Cambridge University Press.
Feldstein, M.
(1983) Domestic Saving and International Capital Movements in the
iong Run and the Short Run. European Economic Review, 21:
129—151.
Feldstein, M. and Horioka, C.
198i. DosEEtic Saving and International Capital Flows. Economic
Journal, 9: 14—329.
Fieleke, N.S.
(1982)
National Saving and International Investment. Saving and
Government Policy. Conference Series no. 25. Boston:
Federal Reserve- Bank of Boston.
Fishman, 6.5.
(199) Spectral Methods in Econometrics. Cambridge, Massachusetts:
Harvard University Press.
Frar.kpl, 3.A.
(1982)
In Search of the Exchange Risk Premium:
A Six—Currency Test
Assuming Mean—Variance Optimization. Journal of International
Money and Finance, 1:
Frankel ,
253—274.
J.A.
(1984) The yen/Dollar Aqreement: Liberalizing Japanese Capital
Markets. Policy Analyses in International Economics rio. 9.
Washington, D.C.:
Institute for International Economics.
Freedn;n, C.
(1q79) A Note on Net Interest Payments to Foreigners under Inflationary
Conditions. Canadian Journal of Economics, 12:
Frenlel ,
291—299.
J.A. and Razin, 4.
(1980) Stochastic Prices and Tests of Efficiency of Foreign Exchange
Markets. EconolTics Letters, 6:
165—170.
Fuller. W.c.
1976) Introduction to Statstij lime Series.
New Yori: Wiley.
F. and Fagano, ri.
(1984J
Capital Controls and the European
Monetary System.
Mimeographed. Univrst of Venice and M.I.T.
Hannan, E.J.
(1970) Muipie Time Series. New York: Wiley.
Hansen, L.P. and Hodrick, R.J.
Forward Exchange Rates as Optimal Predictors of
Future Spot
(1BO>
Rates: An Econometric Analysis. Journal of Political Economy,
88: 829—853.
Hansen, L.P. and Hodrick, R.J.
(1983)
Risk Averse Speculation in the
Forward Foreign Exchange Market:
An Econometric Analysis of Linear
Models. Exchange Rates and
International Macroeconoms. J.A. Frenkel, ed. Chicago:
University of Chicago Press.
Harberger, A.C.
(1978) Perspectives on Capital and Technology in Less Developed
Countries. Contemporary EconomicAnalysis. M.J. Artis and
A.R. Nobay, eds. London.
Harberger, A.C.
(1980) Vignettes on the World Capital Market. American Economic
-54-
Review, 70;
331-337.
Hartman, D.G.
(1984) The International Financial Market and US Interest Rates.
Journal of International Money and Finance, 3: 91—103.
Hodrick, R.J.
(1979)
Some Evidence on the Equality of Expected Real Interest Rates
across Countries. Mimeographed. Carnegie—Mellon University.
Hodrick R.J. and Brivastava, S.
(1984) An Investigation of Risk and Return in Forward Foreign Exchange.
Journal of International Money and Finance, 3:
5—29.
Hodrick R.J. and Srivastava, S.
(19B5)
The Covariation of Risk Premiums and Expected Future Spot
Exchange Rates. Journal of International Money and Finance,
forthcoini ng.
Howard, D.H.
(1979) The Real Rate of interest on international Financial Markets.
International Finance Discussion Papers no. 136, Board of
Sovernors of the Federal Reserve System.
Howard, D.H. and Johnson, K.H.
(1982)
Interest Rates, Inflation, and Taxes: The Foreign Connection.
Economics Letters, 9: 181—184.
-55-
Howard, D.H. and Job cn LH.
(1983)
PurchasnQ Power Parity and Real after Tax Interest Rate
Arbitrae. International Finance Discussion Papers no. 222,
Board of Governors of the Federal Reserve System.
Itc T.
(1983) Capital Controls and Covered
Interest Parity. Working Paper
no. 1187, National Bureau of Economic Research.
Johnston, R.B.
(1979) Some Aspects of the Determination
of Euro—currency Interest
Rates. Bank of England Quarterly Bulletin: 35—46.
Keynes, J.M.
(1919) The Economic Consequences of the Peace. London: Macmillan.
Kotlikoff, L.J.
(1984) iaxation and Savings: A Neoclassical Perspective.
Journal of Economic Literature, 22:
1576—1629.
Kotlikoff, L.J. and Summers, L.H.
(1981)
The Role of Intergenerational Transfers
in Aggregate Capital
Accumulation. Journal of Political Economy, 89: 706—732.
kouri ,
F.J.I<.
(1983.i
The Effect of Risk on Interest Rates:
A Synthesis of the
Macroeconomic and Financial Views. Research
Business and Finance, 3:
301—320.
Ofl
International
C
— u b-
Kreicher, L.L.
(19B2 Eurodollar Arbitrage. Federal Reserve Bank of New York
Quarterly Review, 7:
10—21.
Leff, N. and Sato, K.
(1984) E>ogeneity and Endogeneity in Foreign—Capital Flows to Lat:n
America: A Negative and Cautionary Tale. Mimeographed.
Columbia University.
Lucas, R.E., Jr.
(1982>
Interest Rates and Currency Prices in a Two—Country World.
Journal of Monetary Economics, 10: 335—360.
Plilne, E.
(1977) Tre
6:
Fiscal
Approach to the Balance of Payments. Economic Notes,
89—lOB.
Mishkin, F.S.
(19B4a) The Real interest Rate:
A tiulticountry Empirical Study.
Canadian Journal of Economics, 17: 283—311.
MsMin, F.S.
(1984b) Are Real Interest Rates Equal Across Countries? An Empirical
Investigation of International Parity Conditions. Journal of
Finance, 39:
1345-1358.
tiodigliani, F.
(1970)
The Life Cycle
Hypothesis of Saving and Intercountry Differences
C-,
il-i the Saving Ratio. Inuction,Groth
arid Trade: £5sa in
W.A. Eltis,
Wolfe, eds. Oxford: Oxcrd
M. FG. Scott, arid
J.N.
University Press.
Murphy, R.6.
llcB4) Capital ohiljty and
th Relationship between Saving and investment in OECD Countries.
Journal of International
oney arid
Finance, 3: 327—342,
Obst-feld, M.
(1981) Macroeconomic
Policy, Eiichange—Rate Dynamics, and Optimal Asset
Accumulation. Journal of Political
Econ!, 85:
1142—1161.
Obstfeld, M.
(1962) Can We Sterilje?
Theory and Evidence. American
Economic Review, 72: 45—50.
F'enatj, A. and Dooley, M.
(1984) Current Account
Imbalances and Capital Formation in the industrial
Countries, 1949—81. International
31:
Monetary Fund Staff Papers,
1—24.
Persson, T. and Svensson, L.E.O.
(1985) Current Account
Dynamics and the Terms of Trade:
Harberger_Laursefl_Metzler Two Generations Later.
of Political Economy, 93; 43—65.
Journal
'-IL
ogoff, K.
(1985)
Can Exchange Rate Predictability be Achieved without Monetary
Convergence? Evidence from the EMS. European Economic Review,
forthcoming.
Sachs, 3.8.
(1981) The Current Account and Macroeconomic Adjustment in the 1970s.
Brookings Papers on Economic Activity, 12: 201—268.
Sachs, 3.D.
(1983) Aspects of the Current Account Behavior of OECD Economies.
Recent Issues in the Theory of Flexible Exchange Rates.
E. Claassen and P. Salin, eds. Amsterdam: North—Holland.
Siegel, 3.3.
(1972) Risk, Interest Rates, and the Forward Exchange.
Quarterly Journal of Economics, 86: 303—309.
Singleton, K
(1980) Expectations Models of the Term Structure arid Implied Variance
Bounds. Journal 4 Political Economy 88:
1159—1176.
Stockman, A.C. and Svenssori, L.E.0.
(1984). Capital Flows,, Investment, and Exchange Rates. Mimeoqraphe.
University of Rochester.
Stul, R.M.
(1904) Pricing Capital Assets jr an International Setting: Ar
-59-
Introduction. Working Paper Series no. 64-50, College
of
Adnuriztrative Science, Ohio State University.
Summers, L.H.
'i985
Tax Policy ano International
Competitivenesc
Mimeographed.
Harvard University.
Tohin, 3.
U963) Commn on Domestic
Saving and International
in the Long Run and the Short
Economic Review, 21:
Capital Movements
Run' by M. Feldstein.
European
153—156,
von Furstenberg, G.M.
(1980) Domestic Determinants
of Net U.S. Foreign Investment.
International Monetary Fund Staff Papers, 27: 637—678.
Westphal , U.
(1963)
Comments on Domestic
Saving and International
in the Long Run and the
Capital Movements
Short Run' by M. Feldstein.