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December 1986

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

by Jeffrey A. Frankel

The author examines the contention that “the U.S. economy has become so open financially as to be characterized by perfect capital mobility.” He investigates this belief by reconsidering the observation of Feldstein and Horioka that investment rates and national savings rates are highly correlated, implying low capital mobility. Based on U.S. data for a variety of periods and using several econometric techniques, the author's evidence corroborates the argument that “international capital mobility does not fully prevent exogenous changes in the government budget or in private saving from crowding out domestic investment.” More important, his finds that among the several definitions of perfect capital mobility, the failure of real interest parity automatically explains the findings of crowding out. Thus, he concludes that crowding out takes place not because of imperfect integration of financial markets, but because of imperfect integration of goods markets.