For given values of capital investment, such a target would again imply, residually, a current account target. The ex ante rate of return approach to the measurement of financial integration described above may be contrasted with the ex post approach of examining whether flows of saving and investment have exhibited behavior indicative of integration.
Such an alternative test, based upon the behavior of saving and investment between countries, was proposed by Feldstein and Horioka They argued that in a world characterized by high capital mobility there is no a priori reason to expect saving and investment to be correlated across countries. Savers in different countries face the same interest rate; hence the relative level of saving in one country compared with another is determined by structural factors in the different economies.
Similarly, investors also face the same interest rate, so investment decisions simply depend upon relative investment opportunities. Assuming that structural factors affecting saving and investment are not correlated, domestic saving and investment rates will also be uncorrelated. If, on the other hand, capital mobility is restricted then domestic investors will face a wedge between the cost of domestic and foreign saving, and hence domestic saving and investment will be correlated.
Indeed, in the extreme case of zero capital mobility, saving and investment would be perfectly correlated. In order to test this hypothesis, Feldstein and Horioka ran the following cross-section regression:. These regressions revealed that saving and investment rates were highly correlated, in terms both of levels and medium term changes over time. The estimated coefficients were generally significantly different from zero, but not from one, using both ordinary least squares and instrumental variable techniques, and showed no signs of declining over time.
Subsequent work has confirmed that these coefficients are large and significantly different from zero, although recent data indicate that the coefficients may have fallen somewhat in the s. The results from regressions using equation 1 on data for 23 industrial countries over various time periods are presented in Table 2.
The regressions show large and significant coefficients; for the full period the estimated coefficient using gross saving and investment is 0. The coefficient estimate for the period is 0. In addition to these cross-section results, various authors have found a close correlation between saving and investment over time. Bayoumi , for example, reports the results from running the following equation on annual time series data for ten industrial countries.
This equation is found to yield a positive correlation between saving and investment in all cases except Norway. Moreover, the estimated coefficient is insignificantly different from unity and significantly different from zero for seven of the ten countries. These explanations have substantially different policy implications.
Low international capital mobility implies that policies to promote domestic saving should also raise domestic investment. In contrast, if the correlations reflect private sector behavior in a world of high capital mobility, policy-induced increases in domestic saving will tend to flow abroad unless accommodated by measures to promote investment. Finally, the possibility that governments have been targeting the current account raises the question of the optimality of such a policy, as discussed above.
In order to differentiate among these hypotheses, it is necessary to go beyond the simple regressions outlined in Table 2. One avenue of investigation involves calculating the behavior implied by theoretical models. Obstfeld found that the correlations implied by a simple model of saving-investment behavior were of the same order of magnitude as the observed ones; Frankel and Tesar report similar results for somewhat different theoretical models.
Although these results show that the correlations can be explained by private sector behavior, they do not demonstrate that they are caused by such behavior. A second line of inquiry has involved disaggregating total saving and investment. Feldstein and Horioka examine data for several sectors and conclude that there is little evidence of different sectoral behavior.
Summers regresses the private sector saving investment balance on the government deficit, and finds a strong negative correlation, a result which he attributes to government targeting of the current account. Roubini proposes a model where government policies to smooth taxation produce time series correlations between total saving and investment, and presents regressions supporting this model. However, in both these cases the results also appear compatible with the hypothesis of low international capital mobility.
He argues that this is evidence against explanations based on private sector behavior. He also finds that the time series correlations between saving and investment are reduced when fixed investment is substituted for total investment. Studies have also been made of saving and investment correlations for alternative data sets. Murphy reports the results of running saving-investment regressions using data for the top U.
He finds high correlations and argues this shows evidence that the observed correlations are caused by private sector behavior. Another approach has been to process data derived from regimes which are known to exemplify a high degree of capital market integration. In this spirit, Bayoumi runs saving-investment regressions on international data from the classical gold standard period , while Bayoumi and Rose use postwar data on regional saving and investment for the British Isles: in neither case do the correlations reveal any significant relationship between saving and investment.
At the same time, however, they do not help distinguish between the government policy and low mobility hypotheses. A direct approach to this last question is possible, however. A third approach is to estimate government reaction functions to establish whether the current account has been a major policy objective and, if so, whether there is any evidence of change in this regard.
Generally, policy reaction functions are estimated as reduced-form equations with the government policy variable as the dependent variable, and lagged values of policy targets as the independent variables. Black , in a wide-ranging study of monetary policy in the major industrial countries, concludes that external variables which in his case do not include the current account are relatively unimportant for the United States, but generally have greater weight for other major countries.
Appendix I reports some new work on government reaction functions. Reasonably stable monetary policy reaction functions are identified for several countries; these functions suggest that the current account was a policy target in the s, and that its importance declined in the s.
Interestingly, these results appear as strong for the United States as for other countries. While attempts to estimate stable fiscal policy reaction functions based on lagged variables were not successful, this work did identify a strong negative contemporaneous correlation between the saving-investment balances of the government and private sectors.
These results indicate that the two balances almost completely offset each other in the s, although the correlations have fallen somewhat in the s. If this reflects a policy response, it must be admitted that the degree of policy success is rather surprising; the correlation is of course not incompatible with the alternative hypothesis of low capital mobility.
The fundamental advantage of closer financial integration between countries is that it allows countries to choose paths for consumption and investment which are independent from each other subject to a long-run budget constraint. In a situation of financial autarky, consumption and investment are constrained to add up to the product of the economy, and therefore cannot be considered to be independently determined.
On the other hand, if international financial markets are open, then the sum of consumption and investment can diverge from national product since foreign saving can be used to bridge such gaps. Modern work on consumption usually starts from the Euler equations implied by maximizing behavior.
These models assume that the consumer can borrow and lend freely at a given real interest rate. When these assumptions are combined with other more technical ones, the intertemporal path of consumption can be characterized by the following relationship. This equation states that the marginal utility of consumption today is equal to the expected marginal utility tomorrow, adjusted by the real interest rate and discount factor.
Combined with the assumption of rational expectations, this model predicts that the current change in consumption should not depend upon any lagged information, except the first lag of the real interest rate. The intuition behind this result is that consumption simply depends upon permanent income and the real interest rate.
In any given period, the estimate of permanent income includes all information up to that point, hence no other information should be pertinent to the decision. The international implications of equation 3 have been explored by Obstfeld He noted that, in a world of perfect capital mobility, consumers have access to both home and foreign capital markets. Using a particular functional form for the utility functions, and equating the terms in interest rates for home and foreign consumers, produces the following equation:.
He rejected the model for the period up to the break-up of the Bretton Woods system, but not for the period afterwards. While these results are suggestive of an improvement in the path of consumption, considerable caution should be exercised. The reason for this is the inclusion of a term in the change in the exchange rate in equation 4.
The floating rate period has been characterized by considerable volatility in exchange rates. This adds noise to the realizations of the term within the expectation, making it more difficult to reject the hypothesis. This framework was also used by Bayoumi and Koujianou , using data for six countries from the floating exchange rate period, to examine two hypotheses: whether the model holds for the entire period, and whether it holds better for the more deregulated s than for the s.
Their results indicate that for the entire time period the model can be rejected. The interpretation of the evidence presented above is not entirely without ambiguity. Certain facts are, however, clear. First, considerable liberalization has continued from earlier decades through the s, which has resulted in a closer integration of world capital markets.
For low-risk, short-horizon instruments, at least, capital is now very highly mobile. Second, there has been a marked increase in current account imbalances in the s compared with earlier decades. Third, however, the evidence shows that overall net flows of saving and investment are still markedly insular compared with the paradigms offered by fully integrated capital markets and the evidence from the gold standard period.
Another part of the explanation no doubt has to do with exchange risk. Exchange risk raises the cost of forward cover and may exert a strong deterrent force for those maturities for which forward facilities are nonexistent. Current account imbalances have long been a leading target of economic policy and are one of the indicators closely monitored by the Fund in the context of its surveillance activities, both in consultation with member countries and in the World Economic Outlook. There are a number of factors, however, that might lead a country to be concerned about its external position, particularly in the longer run, even if the current account is regarded as a residual without much consequence in its own right.
This appendix reports the results obtained from policy reaction functions estimated across a number of different countries. The main focus of this work is to examine the degree to which government policy has reacted to the current account, in order to investigate the hypothesis of Summers , among others, that the observed cross-country correlations between saving and investment are due to government policy.
Since there has been a fall in the observed correlation between the s and the s, this work also investigates whether there has been a fall in the importance of the current account as a policy target over the last twenty years. Monetary and fiscal policy reaction functions are estimated directly, using reduced form equations with a policy instrument as the dependent variable and lagged targets as the independent variables. While there are other, more structural, methods of estimating reactions functions Pissarides, , the reduced form approach has been widely used in the literature Joyce, Since they have rather different problems and complications, the monetary and fiscal reaction functions will be discussed separately.
This equation states that the authorities raise or lower interest rates depending upon the recent behavior of three target variables, namely growth of output, inflation, and the size of the current account. The expected signs on these targets are given below the coefficients.
Growth and inflation represent the basic internal targets of monetary policy, while the current account variable represents the external target. Before estimating an equation such as 3 above, there are several issues that should be discussed. The first is the possible endogeneity of the policy variable; if the chosen interest rate is not fully under the control of the authorities, the estimated coefficients may in fact represent endogenous behavior rather than policy decisions.
To avoid this problem the interest rates chosen were the official discount rates. These rates are fully under the control of the authorities, and are generally adjusted in discrete steps such as half a point. A second issue involves the treatment of expectations. The authorities react to expected future changes in the economy, not those which have occurred; hence, ideally, rather than using lagged values of the targets, it would be preferable to use expected future values.
Unfortunately, it is not the actual outcomes of the targets which should be used, but the outcome in the absence of any policy intervention. Since changes in the policy variable affects the future outcome of the targets, it would be necessary to specify a model of the effects of targets upon the economy before the correct expected values could be derived, and any results for the reaction function would involve a joint test of the rest of the model.
To avoid these problems, lagged targets were used in the regressions. This procedure is justified if future expected outcomes are based upon past behavior. Finally, there is an econometric issue which should be considered.
As was noted above, the dependent variable in these regressions moves in discrete steps, while standard regression analysis assumes that the dependent variable is continuous. If it is assumed that there exists an underlying continuous reaction function, but that the actual outcomes are then rounded to the nearest say half a percentage point, the rounding introduces a new source of error into the regression.
As a result, while the estimated coefficients are still unbiased, estimated standard errors will be upward biased. The reported results have been adjusted to take this into account. The coefficient associated with growth is significant at conventional levels in three of the equations, although somewhat surprisingly inflation is only significant for the United States.
Using a one-tailed test the coefficient on the current account is significantly different from zero for both Japan and Germany, is totally insignificant for the United States and has a t-value of 0. These results confirm the conventional view that external factors have been relatively unimportant in the United States, but played a larger role in other countries. Adjusted standard errors are indicated in parentheses.
If government policy is a major cause of the observed correlations between saving and investment, the fall in these correlations between the s and the s should show up in terms of a decline in the importance of the current account as a policy target. Table 4 reports the results of regressions designed to investigate this hypothesis.
In addition to the targets, these regressions include dummy variables that represent the values of the targets in the s. The coefficients on the target variables represent the importance of these targets in the s, while the coefficients on the associated dummy variable show the change in the value of the targets between the s and the s.
The coefficient on the targets for the s can be calculated from the sum of the coefficient on the target and its associated dummy variable. In order to simplify the presentation only current values of the targets are included in the regressions; results using lagged values are broadly similar. DUM equals 0 in s and 1 in s.
These results are also encouraging. The most striking results pertain to the current account variable; all the coefficients relating to the current account in the s have the expected sign and have t-ratios well above unity. Furthermore, all the regressions show a fall in the size of the current account coefficient between the s and the s. Turning to the domestic targets, in the s inflation has a larger and more significant coefficient than growth in all the regressions, and is significant at conventional levels in three of the four.
Overall, these results appear to confirm that the current account was a significant policy target for monetary policy in the s, but that its importance diminished somewhat in the s. This behavior appears to correspond to a reduction in the correlation between saving and investment among OECD countries.
Since the major effect of monetary policy is probably on private sector saving and investment, rather than on the government balance, these data do not provide support for the hypothesis of Summers that it is fiscal policy which has been used to target the current account, rather it appears that governments have sought to influence private sector behavior in response to current account imbalances.
One last issue which should be addressed is whether the estimated reaction functions are stable over time. The data in Table 2 indicate that there are significant changes in the estimated coefficients between the s and the s; the question is whether this instability is important for shorter time periods.
One way of testing this proposition is to estimate rolling regressions. The estimated coefficients, plus their standard errors, can be plotted in order to give a visual impression of the stability of the regression coefficients. This exercise has been carried out using a regression with only current target variables. The results not reported here are somewhat mixed. For the United States and the Federal Republic of Germany the data indicate fairly gradual movements in the coefficients, the Italian data show severe instability while the Japanese data show some instability at the beginning and end of the period.
Overall, these results do not appear to invalidate the results for the longer periods, in that the estimated policy reaction functions are not excessively unstable. In theory, fiscal reaction functions can be estimated in exactly the same manner as monetary functions. However, in practice several factors make estimation more difficult. The first, and most important, has to do with the exogeneity of policy.
Fiscal systems are extremely complex, and the policy instruments which are under the direct control of the government, such as tax rates or allowance provisions, are numerous. Summary measures of policy, such as the deficit or average tax rate, are not entirely under the control of the government given that they are likely to be affected by growth and other factors. This work could be extended to other summary statistics, such as average tax rates.
A second issue concerns the time scale over which fiscal policy is planned. While some adjustments often take place during the year, most fiscal policy changes are announced in the budget. Hence, while monetary policy can be analyzed on a quarterly or monthly basis, fiscal policy is probably best approached using annual data.
This reduces the number of data points available, and lowers the precision of the estimates. Two reaction functions were estimated for twelve industrial countries. The expected signs for the targets are the same as in the monetary regressions; growth and inflation should be associated with rises in the government surplus reductions in the deficit in order to stabilize demand, while changes in the current account should be negatively correlated with the government surplus if the current account is a target.
Table 5 shows the results from estimating the first equation; those from the second equation were broadly similar and are not reported. The coefficients are generally positive, but not significant. More worrying is the fact that all the coefficients on inflation fail to produce the expected sign; it appears that governments reacted to inflation by allowing their budget positions to deteriorate. This may be a result of the fact that inflation raises interest payments on government debt.
The current account coefficients have no consistent sign, and are generally insignificant. The last column of the table shows the results when the six major industrial country equations were estimated as a system, with all the coefficients except the constant constrained to be equal across countries. The system results, which can be seen as a summary of the individual country regressions, indicate that growth has a positive effect on the government surplus, inflation has an insignificant coefficient, while the current account has a significantly positive effect, the opposite to the sign that would be expected if governments target the current account.
Standard errors are indicated in parentheses. The above results from estimating policy reaction functions are mixed. Monetary policy appears to have reacted to the current account, but there is little evidence that fiscal policy did. This section explores the existence of a contemporaneous correlation between the government and private saving investment balances. It should be emphasized, however, that the direction of causation is not clear. The results from these regressions are presented in Table 6.
To test how robust these findings are two further sets of regressions were estimated. Contemporaneous values of growth and inflation were included to test whether the correlations were caused by automatic stabilizers; the results were similar to the initial regressions. Finally, the possibility that these correlations reflect the treatment of all nominal interest payments as income in the national accounts was also examined.
In times of inflation this artificially boosts the income, and hence saving, of net creditors, such as the private sector, while lowering the income and saving of net debtors, such as the government. A crude adjustment for this can be made by increasing government saving by the product of net outstanding government debt and inflation and reducing saving by the private sector by an equal amount.
These calculations were made for the six major industrial countries in the sample, starting in ; the resulting regressions were similar to those without the inflation adjustment. There is also evidence that the importance of these correlations has fallen over time. The results support the thesis that the coefficient has fallen between the s and the s.
Although rarely significant at conventional levels, the results show a fall in the implied correlation over the s in eight of the 12 equations. DUM is a variable equal to 0 for the s and 1 for the s. Overall, there is powerful evidence of a negative correlation between the saving and investment balances of the private and government sectors. The cause of this correlation suggests two explanations, not necessarily exclusive. The first is that international capital mobility is low, although it has risen somewhat over time; hence any imbalance between saving and investment in one area of the economy requires an offsetting imbalance in another sector due to crowding out.
An alternative explanation is that the government targets the current account. Fiscal policy adjustments could be made during the year, producing the contemporaneous correlation, or monetary policy could be directed to the current account, causing movements in both the private and government balances.
Alexander A. International Monetary Fund Washington Vol. Bayoumi T. Black S. Frenkel Chicago : University of Chicago Press Carroll C. Cooper R. Dooley M. Frankel and D. Engle R. Feldstein M. Frankel J. Courakis and M. Taylor London : Macmillan Frenkel Jacob A. Hall R. Hodrick R. Johnston R. Joyce J. Murphy R. Obstfeld M. Pissarides C.
Roubini N. Schmitt H. XLVII pp. Summers L. Frenkel Chicago : Chicago University Press Tesar L. Tobin J. Sachs J. Vines D. Williamson J. Michael Artis is Professor at the University of Manchester. He contributed to this study as a consultant to the Research Department. They would also like to thank Flemming Larsen for suggesting the topic. In effect, of course, governments typically perform a large amount of investment and this should be recognized in empirical analysis of the problem as in the work reported on below—see Section 4.
This in turn indicates that current account surpluses and deficits are not unbounded; verification of the nature of these processes over long periods is an important objective for future research though one that is somewhat hampered by lack of data availability. Frankel provides a comprehensive review of the process of liberalization and computes various associated measures of financial integration.
Offshore CIP i. A representative recent paper is Hodrick and Srivastava Note however that there is no incentive to arbitrage real rates of return. Real return equalization is predicted only where expected depreciation is correctly given by relative expected inflation, i. A country like Japan has had a glut of saving over investment.
This saving has tended to go abroad looking for more profitable investment. Therefore, Japan has had a deficit on capital flows, and a corresponding surplus on the current account. The US, by contrast, has often had a level of investment greater than savings.
This has been financed by capital inflows and a current account deficit. Net income from abroad can be negative if foreigners own more assets in the UK, — income from these assets will be sent abroad leading to negative net income from abroad. Suppose domestic saving is insufficient to finance Domestic investment.
How will the domestic investment be financed? It will be financed by investment from abroad. These capital flows are a credit on the capital account and will be matched by a deficit on the current account. Conversely, if a country has excess savings, these savings will go abroad to finance investment in other countries. This will give a negative balance on the capital account, and enable a current account surplus. Only I will take credit for my investment. When there is a current account deficit it means there has been more domestic currency flowing out of an economy to foreigners.
These loans and investments are recorded as a credit on the capital account. Therefore this creates a glut of investment over savings in the economy, reflecting the current account deficit. Third, people do save and finance the investment as in a closed economy. Banks create the savings when they create the loan. It renders the whole discussion moot, no? Thank you for the explanation, the content is great!
Or can anyone help? Thanks a lot!
Forex Forex News Currency Converter. More Sitemap Definitions. Gayatri Nayak. Font Size Abc Small. Abc Medium. Abc Large. Getty Images Economists also attribute the current slowdown in the economy partly to the fall in the savings rate. Household savings also declined as consumers spent more in purchasing durables and travelling. But India remains favourable compared to emerging market peers such as Brazil.
The previous low was 29 per cent in As a per cent of GDP, household savings fell from 23 per cent in , to 18 per cent last year. Read More News on savings rate capital fund investment economy. Also, ETMarkets. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds. Not even a single parameter is good under Modi's India.
This is the New India he had Mentioned. Melman const 74 days ago. Govt seems to be clueless. Some may cheer for this change. People wish to possess many new gadgets in the preset itself. India will definitely go the developed nations way where savings is low. View Comments Add Comments. Browse Companies:. To see your saved stories, click on link hightlighted in bold. Find this comment offensive?
Unlike money market funds, money market deposit accounts are FDIC-insured. The accounts typically offer lower interest rates than certificates of deposit, but the cash is more accessible. Treasuries are exempt from state and local taxes and are available in different maturity lengths.
The difference between the purchase price and the face value is the interest. Treasury notes, on the other hand, are issued with maturities of 2, 3, 5, 7, and 10 years, and earn a fixed rate of interest every six months. In addition to interest, if purchased at a discount, T-notes can be cashed in for the face value at maturity. When you purchase a bond, you are lending money to one of these entities known as the issuer.
Bonds are issued for a specific period at a fixed interest rate. Each of these bond types involves varying degrees of risk, as well as returns and maturity periods. Also, penalties may be assessed for early withdrawal, commissions may be required, and depending on the type of bond, may carry additional risk, as with corporate bonds where a company could go bankrupt. Savings allow you to squirrel away money while earning modest, low-risk returns.
Due to the large variety of savings vehicles, a little research can go a long way in determining which will work hardest for you. And, since interest rates are constantly changing, it is important to do your homework before committing your money to a particular savings account so you can make the most of your savings.
Federal Deposit Insurance Corporation. Accessed Feb. Department of the Treasury, Bureau of Fiscal Service. Money Market Account. Mutual Funds. Savings Accounts. Roth IRA. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways If you're not earning any interest on your savings, your savings will be worth less over time due to inflation There are a number of different types of accounts you can choose from for your savings Compare rates before you open an account to ensure you maximize your savings.
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Investment is a component of aggregate demand. Most countries in the midst of credit booms run sizable external deficits. China, by contrast, still runs a meaningful current account surplus. China is exporting savings even as it invests close to 45 percent of its GDP. That is what differentiates China from most countries that experience a credit and investment boom.
A high level of national savings—national savings has been close to 50 percent of GDP for the last ten years, and was 48 percent of GDP in , according to the IMF WEO data —creates an on-going risk that China will either over-supply savings to its own economy, leading to domestic excesses, or to the world, adding to the risks from global payments imbalances.
From this point of view, the high level of investment, and the risks that come from high levels of investment, flow in part from the set of policies that have given rise to extraordinarily high levels of domestic savings. After the global financial crisis, the vast bulk of Chinese savings now is invested, no doubt rather inefficiently, at home.
But even with a high level of investment spurred by rapid growth in domestic credit some Chinese savings still bleeds out into the world economy. That is what low global interest rates and weak global demand growth are telling us. Less investment means less demand for imports. The imported component of investment is, for now, much higher than the imported component of consumption. It is increasingly clear that the slowdown in Chinese investment in and had a larger global impact—counting the second-order impact on commodity prices and investment in commodity production—than was initially expected.
Lower savings would mean China could invest less at home without the need to export savings to the rest of the world. Lower savings implies higher levels of consumption, whether private or public, and more domestic demand. Lower savings would tend to put upward pressure on interest rates, and thus reduce demand for credit. It would result in lower domestic risks and lower external risks. So I worry a bit when policy advice for China focuses primarily on reducing investment, without an equal emphasis on the policies to reduce Chinese savings.
But I also am not sure that it is enough to just slow credit. Even as the off-balance sheet deficit falls and the on-budget fiscal deficit remains roughly constant. The actual fall in savings from to was rather modest, so the IMF is projecting a bit of a change. Therefore, Japan has had a deficit on capital flows, and a corresponding surplus on the current account. The US, by contrast, has often had a level of investment greater than savings.
This has been financed by capital inflows and a current account deficit. Net income from abroad can be negative if foreigners own more assets in the UK, — income from these assets will be sent abroad leading to negative net income from abroad. Suppose domestic saving is insufficient to finance Domestic investment.
How will the domestic investment be financed? It will be financed by investment from abroad. These capital flows are a credit on the capital account and will be matched by a deficit on the current account. Conversely, if a country has excess savings, these savings will go abroad to finance investment in other countries.
This will give a negative balance on the capital account, and enable a current account surplus. Only I will take credit for my investment. When there is a current account deficit it means there has been more domestic currency flowing out of an economy to foreigners. These loans and investments are recorded as a credit on the capital account. Therefore this creates a glut of investment over savings in the economy, reflecting the current account deficit.
Third, people do save and finance the investment as in a closed economy. Banks create the savings when they create the loan. It renders the whole discussion moot, no? Thank you for the explanation, the content is great! Or can anyone help? Thanks a lot! You can look at it this way: your production GNP is equal to your income GNI ; and you use your income for consumption household C and government G and for saving S ; thus.
I was looking through the causes of a current account surplus in a text book and one cause was: a net inflow of investment income.