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Is the Feldstein-Horioka Puzzle Really a Puzzle?

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  • Daniel Levy

    ()
    (Bar-Ilan University and Emory University)

Abstract

Using the framework of a dynamic intertemporal optimization model of an open economy, it is shown that the long-run investment-saving correlation follows directly from the economy’s dynamic budget constraint and this does not depend on the degree of international capital mobility. Therefore, unless the budget constraint is violated, the time series of investment and saving should be cointegrated, and this should be true for any degree of capital mobility. Using an improved econometric technique, which encompasses the tests used by previous authors and avoids some of the pitfalls associated with their tests, I show that their conflicting findings can be explained by a simple but important, omitted variables problem. Using annual and quarterly post-war U.S. data, I find that investment and saving are cointegrated in levels as well as in rates, regardless of the time period considered, as predicted by the model.

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Bibliographic Info

Paper provided by Department of Economics, Bar-Ilan University in its series Working Papers with number 2003-02.

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Date of creation: Jun 2003
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Handle: RePEc:biu:wpaper:2003-02

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Keywords: Capital Mobility; Investment-Saving Correlation; Dynamic Budget Constraint; Integration and Cointegration; Omitted Variables.;

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References

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  1. Tsoukis, C. & Alyousha, A., 2000. "A Re-Examination of Saving - Investment Relationships: Cointegration, Causality and International Capital Mobility," Papers 271, Universite de Nantes - Economie Internationale et de l'Entreprise.
  2. Daniel Levy, 1995. "Investment-saving comovement under endogenous fiscal policy," Open Economies Review, Springer, vol. 6(3), pages 237-254, July.
  3. Daniel Levy, 2000. "Investment-Saving Comovement and Capital Mobility: Evidence from Century Long U.S. Time Series," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 100-137, January.
  4. Sinn, Stefan, 1992. "Saving-Investment Correlations and Capital Mobility: On the Evidence from Annual Data," Economic Journal, Royal Economic Society, vol. 102(414), pages 1162-70, September.
  5. Feldstein, Martin, 1983. "Domestic saving and international capital movements in the long run and the short run," European Economic Review, Elsevier, vol. 21(1-2), pages 129-151.
  6. Jeffrey A. Frankel & Alan T. MacArthur, 1987. "Political vs. Currency Premia in International Real Interest Differentials: A Study of Forward Rates for 24 Countries," NBER Working Papers 2309, National Bureau of Economic Research, Inc.
  7. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  8. Barro, R. & Mankiw, G., 1992. "Capital Mobility in Neoclassical Models of Growth," Harvard Institute of Economic Research Working Papers 1615, Harvard - Institute of Economic Research.
  9. Miller, Stephen M., 1988. "Are saving and investment co-integrated?," Economics Letters, Elsevier, vol. 27(1), pages 31-34.
  10. Levy, D., 1990. "Investment-Saving Comovement, Capital Mobility, And Fiscal Policy," Papers 90-91-04, California Irvine - School of Social Sciences.
  11. Baxter, Marianne & Crucini, Mario J, 1993. "Explaining Saving-Investment Correlations," American Economic Review, American Economic Association, vol. 83(3), pages 416-36, June.
  12. Sachsida, Adolfo & Caetano, Marcelo Abi-Ramia, 2000. "The Feldstein-Horioka puzzle revisited," Economics Letters, Elsevier, vol. 68(1), pages 85-88, July.
  13. Frankel, Jeffrey A., 1989. "Quantifying International Capital Mobility in the 1980s," Department of Economics, Working Paper Series qt4fw7c7bh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  14. Ghosh, Atish R, 1995. "International Capital Mobility amongst the Major Industrialised Countries: Too Little or Too Much?," Economic Journal, Royal Economic Society, vol. 105(428), pages 107-28, January.
  15. repec:fth:galeco:49 is not listed on IDEAS
  16. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  17. B. Douglas Bernheim & John B. Shoven, 1991. "National Saving and Economic Performance," NBER Books, National Bureau of Economic Research, Inc, number bern91-2, July.
  18. Glenn Otto & Tony S. Wirjanto, 1989. "National Savings and Domestic Investment in the Long Run: Some Time Series Evidence for the U.S. and Canada," Working Papers 754, Queen's University, Department of Economics.
  19. Helen Popper, 1990. "International capital mobility: direct evidence from long-term currency swaps," International Finance Discussion Papers 386, Board of Governors of the Federal Reserve System (U.S.).
  20. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
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Citations

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Cited by:
  1. Daniel Levy, 2005. "Investment-Saving Comovement under Endogenous Fiscal Policy," International Finance 0505008, EconWPA.
  2. Andrew T. Young & Matthew J. Higgins & Daniel Levy, 2013. "Heterogeneous Convergence," Working Papers 2013-04, Department of Economics, Bar-Ilan University.
  3. Matthew J. Higgins & Daniel Levy & Andrew T. Young, 2005. "Growth and Convergence across the US: Evidence from County-Level Data," Working Papers 2005-06, Department of Economics, Bar-Ilan University.
  4. Aristovnik, Aleksander & Djurić, Sandra, 2010. "Twin deficits and the Feldstein-Horioka puzzle: a comparison of the EU member states and candidate countries," MPRA Paper 24149, University Library of Munich, Germany.
  5. Daniel Levy, 2005. "Investment-Saving Comovement and Capital Mobility: Evidence from Century Long U.S. Time Series," International Finance 0505006, EconWPA, revised 16 May 2005.
  6. Aleksander Aristovnik, 2005. "Twin Deficits Hypothesis And Horioka-Feldstein Puzzle In Transition Economies," International Finance 0510020, EconWPA.
  7. João Sousa Andrade, 2006. "Mobilidade do Capital e Sustentabilidade Externa: uma aplicação da tese de F-H a Portugal (1910-2004)," GEMF Working Papers 2006-04, GEMF - Faculdade de Economia, Universidade de Coimbra.

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