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International Capital Mobility and Crowding Out in the U.S. Economy: Imperfect Integration of Financial Markets or of Goods Markets?

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  • Jeffrey A. Frankel

Abstract

Conventional wisdom in the field of international finance holds that the U.S. economy has become so open financiallly as to be characterized by perfect capital mobility: a highly elastic supply of foreign capital prevents the domestic rate of return from rising significantly above the world rate of return. This view has been challenged recently by the observation that investment rates are highly correlated with national saving rates, and the claim by Feldstein and Horioka that this correlation is evidence of relatively low capital mobility.The premise of this paper is that the Feldstein-Horioka finding regarding crowding out in an open economy is strong enough to survive the econometric critiques that have been leveled against it, but that it need have nothing to do with the degree of capital mobility in the sense of the openness of financial markets and the equalization of international interest rates expressed in a common currency. It is real interest rates that matter for questions of crowding out, and real interest parity requires not just that nominal interest rates be equalized expressed in a common currency, but also that purchasing power parity hold. It is well-known that purchasing power parity does not in fact hold. Currently, for example, the dollar is expected to depreciate in real terms. Thus real interest rate parity fails and crowding out takes place because of imperfect integration of goods markets, not imperfect integration of financial markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1773.

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Date of creation: Dec 1985
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Publication status: published as Jeffrey A. Frankel, 1985. "International capital mobility and crowding-out in the U.S. economy: imperfect integration of financial markets or of goods markets?," Proceedings, Federal Reserve Bank of St. Louis, pages 33-74.
Handle: RePEc:nbr:nberwo:1773

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  1. Jeffrey A. Frankel & Charles Engel, 1982. "Do Asset-Demand Functions Optimize over the Mean and Variance of Real Returns? A Six-Currency Test," NBER Working Papers 1051, National Bureau of Economic Research, Inc.
  2. Frederic S. Mishkin, 1982. "Are Real Interest Rates Equal Across Countries? An Empirical Investigation of International Parity Conditions," NBER Working Papers 1048, National Bureau of Economic Research, Inc.
  3. David, Paul A & Scadding, John L, 1974. "Private Savings: Ultrarationality, Aggregation, and "Denison's Law."," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(2), pages 225-49, Part I, M.
  4. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 90(358), pages 314-29, June.
  5. John F. O. Bilson & Richard C. Marston, 1984. "Exchange Rate Theory and Practice," NBER Books, National Bureau of Economic Research, Inc, number bils84-1, July.
  6. Lars Peter Hansen & Robert J. Hodrick, 1983. "Risk Averse Speculation in the Forward Foreign Exchange Market: An Econometric Analysis of Linear Models," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 113-152 National Bureau of Economic Research, Inc.
  7. Benjamin M. Friedman, 1985. "Implications of the U.S. net capital inflow," Proceedings, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, pages 137-167.
  8. Murphy, Robert G., 1984. "Capital mobility and the relationship between saving and investment rates in OECD countries," Journal of International Money and Finance, Elsevier, Elsevier, vol. 3(3), pages 327-342, December.
  9. David G. Hartman, 1980. "The International Financial Market and U.S. Interest Rates," NBER Working Papers 0598, National Bureau of Economic Research, Inc.
  10. Jeffrey A. Frankel, 1985. "The Implications of Mean-Variance Optimization for Four Questions in International Macroeconomics," NBER Working Papers 1617, National Bureau of Economic Research, Inc.
  11. Robert E. Cumby & Frederic S. Mishkin, 1987. "The International Linkage of Real Interest Rates: The European - U.S. Connection," NBER Working Papers 1423, National Bureau of Economic Research, Inc.
  12. Krugman, Paul R., 1978. "Purchasing power parity and exchange rates : Another look at the evidence," Journal of International Economics, Elsevier, Elsevier, vol. 8(3), pages 397-407, August.
  13. Barry P. Bosworth, 1985. "Taxes and the Investment Recovery," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 16(1), pages 1-45.
  14. Frankel, Jeffrey A., 1982. "In search of the exchange risk premium: A six-currency test assuming mean-variance optimization," Journal of International Money and Finance, Elsevier, Elsevier, vol. 1(1), pages 255-274, January.
  15. Hartman, David G., 1984. "The international financial market and US interest rates," Journal of International Money and Finance, Elsevier, Elsevier, vol. 3(1), pages 91-103, April.
  16. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
  17. Cumby, Robert E & Obstfeld, Maurice, 1981. "A Note on Exchange-Rate Expectations and Nominal Interest Differentials: A Test of the Fisher Hypothesis," Journal of Finance, American Finance Association, American Finance Association, vol. 36(3), pages 697-703, June.
  18. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(2), pages 370-84, April.
  19. Martin Feldstein, 1982. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Working Papers 0947, National Bureau of Economic Research, Inc.
  20. Gerard Caprio & David H. Howard, 1983. "Domestic saving, current accounts, and international capital mobility," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 244, Board of Governors of the Federal Reserve System (U.S.).
  21. Harberger, Arnold C, 1980. "Vignettes on the World Capital Market," American Economic Review, American Economic Association, American Economic Association, vol. 70(2), pages 331-37, May.
  22. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, American Economic Association, vol. 65(5), pages 900-922, December.
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