Does Domestic Savings Limit Investment In Australia
Introduction
Neoclassical macroeconomic theory suggest that domestic savings is equal to domestic investment in an economy. This is based on the assumption that capital is immobile and all investment is financed from domestic savings and foreign capital is not required. However, the condition does not hold for an open economy such as Australia, which is heavily reliant on foreign investments. This is shown evidently through the Australian Current Account Deficit; that is at least 7% of its GDP with Net Foreign Debt making up at least 50% of GDP amounting to $422 billion (ABS 2008). It is then argued that capital is perfectly mobile because all domestic investment can be financed through foreign borrowing and not just by domestic savings. Theory suggests that Australian investment would be a function of the world savings pool and savings a function of the world opportunities to invest. Thus, having a priori expectation that the relationship between savings and investment ratios to be zero. However, Feldstein-Horioka (1980) shows otherwise, as savings and investment still exhibited a positive linear relationship when a sample of 16 OCED countries is regressed. This led the authors to conclude that capital mobility was relatively low across countries, and was not increasing over time. This paradox is famously labeled as the “Feldstein and Horioka’s Saving-Investment puzzle.”
This paper aims to test and validate empirically if domestic saving limits investment in Australia. The implications for the Feldstein-Horioka of capital mobility are explained.
Statistical Analysis
To test the hypothesis that the long run Australian Investment and Savings are unrelated, this paper uses a time series regression with the investment ratio (I/Y) as the regressand and savings ratio (S/Y) as the regressor, where both are proportions of gross national income (Y). The data is based on the major components of Australia’s...
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