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The quantity approach to financial integration: The Feldstein-Horioka criterion revisited

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Abstract

This paper applies the Feldstein-Horioka criterion, that is, the role of savings-investment correlations, to assess the degree of financial integration in the European Community. We establish a link between the Feldstein-Horioka criterion and three other criteria for financial integration: the covered, uncovered, and real interest parity condition. Subsequently, we evaluate the Feldstein-Horioka criterion for financial integration on the basis of its underlying assumptions. The paper performs both cross-section and time-series analyses of savings-investment correlations. The time-series analysis relies on the concept of cointegration. Our major finding is that the Feldstein-Horioka criterion—contrary to what is usually found in world financial markets—is able to explain an increasing degree of financial integration in the European Community.

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Abbreviations

S:

gross national savings

I:

gross domestic investment

C:

total private and government final consumption expenditure

M:

import of goods and services

X:

export of goods and services

Y:

gross domestic product

CA:

current account of the balance of payments

GNP:

gross national product

NCT:

net current transfers from the rest of the world

NFI:

net factor income from the rest of the world

FCF:

gross fixed capital formation

ST:

increase in stocks

Sp :

gross national savings by the private sector

Sg :

gross national savings by the public sector

Ip :

gross domestic investment by the private sector

Ig :

gross domestic investment by the government sector

′:

corrected for a nonzero value of the statistical discrepancy

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Authors and Affiliations

  1. Department of Economics and Center for Economic Research, Tilburg University, The Netherlands

    Jan J. G. Lemmen & Sylvester C. W. Eijffinger

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  1. Jan J. G. Lemmen
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  2. Sylvester C. W. Eijffinger
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Lemmen, J.J.G., Eijffinger, S.C.W. The quantity approach to financial integration: The Feldstein-Horioka criterion revisited. Open Econ Rev 6, 145–165 (1995). https://doi.org/10.1007/BF01001234

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