There are three &nbspbroad &nbspapproaches to testing international capital mobility: interest rate comparisons; correlation between savings and investment; and comparisons of consumption patterns. In Discussion Paper No.1030, Research Associate Tamim Bayoumi and Ronald McDonald provide a test using data on consumption across Canadian provinces. The logic behind the consumption test is that, in the absence of capital market imperfections, individuals will use capital markets to insulate themselves against idiosyncratic income disturbances.

The authors assess whether or not the apparently highly integrated Canadian capital markets facilitate highly integrated consumption paths across provinces. The results indicate that consumption appears to be highly integrated within the central and eastern core of the economy (provinces that comprise around 70% of the Canadian economy), while the western provinces have consumption paths which are both highly dependent upon local income and badly correlated with national consumption. This appears to reflect the large size of idiosyncratic income disturbances in the western provinces, due to the importance of primary industries in the local economies. These results indicate that capital markets which appear highly integrated do not automatically ensure highly integrated regional consumption patterns. A more general message is that, in the absence of such large idiosyncratic income disturbances, integrated capital markets do indeed provide consumption paths which are close to optimal.

On the Optimality of Consumption Across Canadian Provinces
Tamim A Bayoumi and Ronald McDonald

Discussion Paper No. 1030, October 1994 (IM)