VALUE INVEST - Valuation & Research Specialists

38
Harilaos Mertzanis
cushion against extreme manifestation
of systemic risk. Thus, the effectiveness
of MiFID in reducing the adverse
effects of market fragmentation may
come at the cost of raising the likelihood
of systemic risk.
2.2 Macroeconomic issues
The role of financial markets in bringing
savings and investment decisions
by individuals into balance is crucial.
Feldstein-Horioka (1980) found that
domestic savings rates are typically
highly correlated with domestic
investment rates, suggesting that there
is a small degree of international
financial market integration, for if
integration were deeper savings decisions
in one location would be independent
of investment decisions in
that location. This result sparked considerable
debate. On the one hand, the
F-H result seems generally to hold:
States do not seem to use as much as
they could financial markets to fully
separate savings and investment decisions,
to diversify risk and smoothly
absorb exogenous shocks (Obstfield,
1986; Lewis, 1995; Bayoumi, 1997;
the literature grows large). Thus, current
account imbalances in many
States seem to be conditioned by capital
account inflexibilities. On the other
hand, there is considerable evidence
against the F-H result: correlation
between national savings and national
investment is weaker than previously
thought and is declining over time
(Blecker, 1997; Gordon, 1996, 1997).
The fact that EU current account
deficits have been large and variable is
not consistent with the F-H result,
and thus domestic savings may not be
considered as constraining EU investment.
There are two types of evidence indicating
that national borders and separate
financial intermediation structures
limit financial market integration.
First, personal savings and
investment decisions are basically
uncorrelated in separate regions within
States, in contrast to the high
degree of correlation between States,
implying a higher degree of capital
market integration within States
(Bayoumi 1997; Helliwell, 1998). This
evidence is supported by a historic
analysis of cross-country savings and
investment flows during the Gold
Standard era. Bayoumi (1997) points
out that, prior to 1914, exchange rates
were fixed and capital was highly
mobile, and the correlation between
savings and investment in different
States was considerably smaller than
it is today. Irwin (1996) offers a slightly
different interpretation, by arguing
that capital market integration was
high during the Gold Standard era for
only a limited variety of heavily traded
financial assets existed at the time.
This evidence is interesting as it suggests
that the issue is not only one of
international borders, but of currency
and structural regimes as well. In
addition to the role of different currencies,
the role of Government in
economies was much smaller and
financial intermediation was limited
and less sophisticated during the Gold
Standard era than it is today, and
Governments had a legitimate role or
incentive to intervene in the international
gold market or in the regulation
of financial firms for domestic policy
reasons. In contrast, modern
Governments do worry about the current
account position and the efficiency
of financial regulation, and can find
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