Martin Feldstein and Charles Horioka of Harvard University argues that in a world of perfect capital market integration, there should be little long term correlation between domestic saving and investment. Explain. What factors might explain closer than expected correlation observed?
Read the paper to understand the logic for the answer to this question:
Domestic Saving and International Capital Flows
Feldstein, Martin, Horioka, Charles. The Economic Journal. London: Jun 1980.Vol.90, Iss. 358; pg. 314
In the perfect capital market integration, there should be very little long term correlation between domestic savings and investment.
When the capital markets are perfectly closed (no integration), whatever investments are there in the economy that has to come from the savings in the economy. For example, if U.S. market is closed (no fund mobility is allowed between U.S. and other markets), then the investments in U.S. markets are funded from the savings in the U.S. market, So the correlation between the domestic savings and investment is likely to be very high.
But when the markets are open and there is ...
The solution discusses what factors might explain closer than expected correlation observed.