Financial crisis and saving-investment dynamics in the presence of cross-sectional dependence: The case of East Asia

- Saving and investment rates are highly dependent across countries of East Asia.
- The crisis of 1997 has caused structural breaks in saving-investment relationship.
- The global financial crisis of 2008 has not affected the saving-investment dynamics.
- These financial crises have not influenced the long run saving-investment behavior.
- The prediction of new open economy macroeconomic theories is verified in East Asia.

Using the common correlated effects mean group (CCEMG) technique to a set of balanced panel error correction model, we examine the effects of the Asian financial crisis of 1997, and the global financial crisis of 2008 on the behavior of saving and investment in East Asian countries. Our results show that saving and investment rates are highly dependent across countries of East Asia. This finding underlines the importance of taking into account cross-sectional dependence when analyzing saving-investment relationship. The results also indicate that the adverse financial shock of 1997 has negatively affected the short run correlation between saving and investment, but has not influenced their long run relationship. Our finding, hence, verifies the prediction of new open economy macroeconomic theories regarding the divergence of short run saving-investment from its long run trend for East Asia. Moreover, we find that the global financial crisis of 2008 has not affected the saving-investment dynamics in this region. It means that the consequences of the Asian and global financial crises for saving-investment dynamics are not the same in East Asia. One might attribute these differences to the origins of these two shocks, i.e., internal versus external to the region. These findings may have some policy implications for those countries that rely heavily on foreign investment and are subject to various internal and external financial shocks.