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December 1986

Implications of the U.S. Net Capital Inflow

by Benjamin M. Friedman

The author notes that the massive inflow of capital from abroad has been a key factor in equilibrating savings and investments in the United States despite large federal government deficits. The author argues that financial activity will shift away from capital formation as the increased foreign ownership of U.S. financial assets increases the “expected return premium on long-term debt.” The policy implications the author derives are that easing monetary policy would reduce the capital inflow and, therefore, stimulate capital formation. In terms of fiscal policy, he argues that a similar outcome would arise from a tightening of fiscal policy, most notable through a reduction of large federal budget deficits.