~) Pergamon Journal of International MoncT and Finance, Vol. 16. No. 6, pp. 837 863. 1997 Published by Elsevier Science Lid Printed in Great Britain PII: S0261-5606(97100040-5 11261-56116/97 $17.00 + 0.00 Saving-investment dynamics and capital mobility in the US and Japan RAMON MORENO* Federal Reserve Bank of San Francisco, Economic Research Department, 101 Market Street, San Francisco, CA 94105, USA This paper points out that a high long-run correlation between saving and investment is better interpreted as reflecting the operation of a country's intertemporal budget constraint rather than as an indicator of capital mobility. Inferences about capital mobility can instead be made from the divergent short-run dynamic responses of saving and investment to shocks. Using post-war quarterly data for the US and Japan, the paper assesses the characteristics of saving and investment behavior under different regulatory environments. It finds mixed evidence of changes in the short- run dynamics of saving and investment that suggest increased capital mobility in the 1980s. (JEL E2, F21). Published by Elsevier Science Ltd. In an influential study, Feldstein and Horioka (1980) tested the intuitively appealing proposition that in fully integrated world capital markets, there is no correlation between a nation's saving rate and its rate of investment. To the surprise of many, Feldstein and Horioka found a high correlation between long-term saving and investment of OECD countries and that the coefficient of a regression of investment on saving is close to unity. This result, which holds in both cross-section and time series data, is surprising because it seems at odds with large and persistent external imbalances that have been observed in OECD economies, as well as indications of large gross and net capital flows in these economies since the 1970s. A Variety of explanations have been offered to reconcile Feldstein and Horioka's findings of a high coefficient with a high degree of capital mobility. One explanation is that estimates are contaminated by simultaneous equation bias, because of the endogeneity of both investment and saving. As shown by Obstfeld 1991, p. 267), the bias may remain even when instrumental variables are used. Another explanation is that the Feldstein-Horioka sample was too short to capture increases in capital mobility that became particularly apparent *I would like to thank two anonymous referees, Ken Kasa and Bharat Trehan for useful comments. I would also like to thank Barbara Rizzi for tireless and thoughtful research assistance. The views expressed in this paper are those of the author and do not necessarily reflect the position of the Board of Governors of the Federal Reserve System or of the Federal Reserve Bank of San Francisco. 837