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The Feldstein-Horioka puzzle: The IS-LM model with optimal policy

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  • J. Mcclure
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    Abstract

    The high correlations between saving and investment, which suggest a small variability of the current account, is explored within an IS-LM framework. While Feldstein and Horioka interpret this evidence to imply a low degree of capital mobility, the pattern of shocks to the model is also important. If the monetary authorities are pegging domestic rates to foreign returns, then we would expect the Feldstein-Horioka evidence even under high mobility. We explore whether such a rule is optimal when policymakers wish to avoid income variability where fiscal and monetary policy are coordinated and where monetary policy must act alone. We suggest that the Voicker Federal Reserve switched to the latter stance and created a dramatic exception to the Feldstein-Horioka paradox. Copyright Kluwer Academic Publishers 1994

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    File URL: http://hdl.handle.net/10.1007/BF01000721
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    Bibliographic Info

    Article provided by Springer in its journal Open Economies Review.

    Volume (Year): 5 (1994)
    Issue (Month): 4 (October)
    Pages: 371-382

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    Handle: RePEc:kap:openec:v:5:y:1994:i:4:p:371-382

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    Web page: http://www.springerlink.com/link.asp?id=100323

    Related research

    Keywords: Current account variability; external balance hypothesis; Feldstein-Horioka paradox; fiscal policy; income variability; monetary policy;

    References

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    1. Martin Feldstein, 1991. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 331-353 National Bureau of Economic Research, Inc.
    2. Hallett, A. J. Hughes, 1987. "The impact of interdependence on economic policy design : The case of the USA, EEC and Japan," Economic Modelling, Elsevier, vol. 4(3), pages 377-396, July.
    3. Gundlach, Erich & Sinn, Stefan, 1991. "Unit root tests of the current account balance: implications for international capital mobility," Kiel Working Papers 495, Kiel Institute for the World Economy.
    4. Michael Dooley & Jeffrey Frankel & Donald J. Mathieson, 1987. "International Capital Mobility: What Do Saving-Investment Correlations Tell Us?," IMF Staff Papers, Palgrave Macmillan, vol. 34(3), pages 503-530, September.
    5. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
    6. Martin Feldstein & Philippe Bacchetta, 1992. "National Saving and International Investment," NBER Working Papers 3164, National Bureau of Economic Research, Inc.
    7. Currie, David, 1993. "International Cooperation in Monetary Policy: Has It a Future?," Economic Journal, Royal Economic Society, vol. 103(416), pages 178-87, January.
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    Cited by:
    1. Ndikumana, Leonce, 2000. "Financial Determinants of Domestic Investment in Sub-Saharan Africa: Evidence from Panel Data," World Development, Elsevier, vol. 28(2), pages 381-400, February.
    2. Ramon Moreno, 1994. "Saving-investment dynamics and capital mobility in the U.S. and Japan," Pacific Basin Working Paper Series 94-05, Federal Reserve Bank of San Francisco.
    3. Chu, Kam Hon, 2012. "The Feldstein-Horioka Puzzle and Spurious Ratio Correlation," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 292-309.
    4. W. Jansen, 1998. "Interpreting Saving-Investment Correlations," Open Economies Review, Springer, vol. 9(3), pages 207-219, July.

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