Patients at risk for psychiatric hospitalization make only limited use of outpatient services, although clinical research has demonstrated that outpatient treatments and home care can be as effective as inpatient psychiatric treatment in treating certain mental health problems. The substitution of ambulatory services for inpatient care has in part been limited because insurers have restricted outpatient mental health benefits to control utilization. The authors critically review evidence from the economic and clinical literatures to determine the extent to which outpatient psychiatric treatment substitutes or complements inpatient treatment. To encourage clinically effective substitution of outpatient for inpatient services, further research is needed to identify the patient populations for whom substitution is possible and the treatment and environmental conditions in which it is most likely to be successful.