Intranational Financial Integration: Evidence from the Canadian Banking Industry
Feldstein and Horioka (1980) argued that if international capital markets are fully integrated, then national savings rates and national investment will be uncorrelated. The basis for the argument is that financial integration allows borrowers and lenders to engage in financial transactions in any country. Hence, borrowing to finance investment in a nation does not rely on the saving behavior of the nation. They found that national saving and investment rates are highly correlated suggesting that there is not complete integration of international financial markets. Subsequent research pointed out ways that this correlation could occur even if there was complete integration of capital markets. For example, financial integration will be apparent only when there is a need for capital to flow across regions, which requires uncommon, or relative, shocks to each county’s saving and/or investment demand. With common shocks, there is no need for capital to flow across countries and so it will stay at home, which causes national saving and investment to be highly correlated even if there is complete capital market integration. Consequently, any test of financial integration must control for common shocks to the regions.
KeywordsMonetary Policy Relative Growth Rate Impulse Response Function Quarterly Data Financial Integration
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