Exploring the effects of capital mobility on the saving–investment nexus: evidence from Icelandic historical data

Abstract

We explore the effects of capital mobility on the relationship between saving and investment using historical data for Iceland. First, we analyse the saving-investment (S-I) correlation for the period of restricted capital mobility using data from 1960 and 1994. We then add a period of free capital mobility between 1994 and 2008 and estimate the correlation for the period 1960-2008. Finally, we extend our analysis to the 2008 to 2016 period, when capital controls were imposed in response to the crisis. Institutions matter: We find institutional changes, in particular Iceland's entry into the European Single Market in 1994, coincided with a fall in the long-run correlation between saving and investment. However, the correlation weakens further when we include the post-crisis regime of capital controls, suggesting a weaker relationship between savings and investment in this regime. We discuss the possible reasons for this pattern and also the implications of our findings for post-crisis policy in small open economies.