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Is the Feldstein-Horioka Puzzle Really a Puzzle?

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  • Daniel Levy

    (Bar-Ilan & Emory)

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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File URL: http://128.118.178.162/eps/if/papers/0402/0402002.pdf
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Bibliographic Info

Paper provided by EconWPA in its series International Finance with number 0402002.

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Length: 33 pages
Date of creation: 07 Feb 2004
Date of revision: 12 May 2005
Handle: RePEc:wpa:wuwpif:0402002

Note: Type of Document - pdf; prepared on Win 98; to print on Any printer; pages: 33 ; figures: Figures are included
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Web page: http://128.118.178.162

Related research

Keywords: Capital Mobility; Investment-Saving Correlation; Dynamic Budget Constraint; Integration; Cointegration; Omitted Variables in Cointegration; International Capital Mobility; Long-Term Capital Mobility; Feldstein-Horioka Puzzle; Investment-Saving Comovement; Investment-Saving Cointegration; Intertemporal Optimization;

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References

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  1. Robert J. Barro & N. Gregory Mankiw & Xavier Sala-i-Martin, 1994. "Capital mobility in Neoclassical models of growth," Economics Working Papers 82, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Jeffrey A. Frankel, 1989. "Quantifying International Capital Mobility in the 1980s," NBER Working Papers 2856, National Bureau of Economic Research, Inc.
  3. 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.
  4. 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.
  5. Baxter, Marianne & Crucini, Mario J, 1993. "Explaining Saving-Investment Correlations," American Economic Review, American Economic Association, vol. 83(3), pages 416-36, June.
  6. repec:fth:galeco:49 is not listed on IDEAS
  7. 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.
  8. Martin Feldstein, 1982. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Working Papers 0947, National Bureau of Economic Research, Inc.
  9. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  10. 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.).
  11. Sachsida, Adolfo & Caetano, Marcelo Abi-Ramia, 2000. "The Feldstein-Horioka puzzle revisited," Economics Letters, Elsevier, vol. 68(1), pages 85-88, July.
  12. 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.
  13. 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.
  14. 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.
  15. Miller, Stephen M., 1988. "Are saving and investment co-integrated?," Economics Letters, Elsevier, vol. 27(1), pages 31-34.
  16. B. Douglas Bernheim & John B. Shoven, 1991. "National Saving and Economic Performance," NBER Books, National Bureau of Economic Research, Inc, number bern91-2.
  17. Daniel Levy, 1995. "Investment-saving comovement under endogenous fiscal policy," Open Economies Review, Springer, vol. 6(3), pages 237-254, July.
  18. 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.
  19. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  20. Levy, D., 1990. "Investment-Saving Comovement, Capital Mobility, And Fiscal Policy," Papers 90-91-04, California Irvine - School of Social Sciences.
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Citations

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Cited by:
  1. Andrew Young & Matthew Higgins & Daniel Levy, 2013. "Heterogeneous Convergence," Emory Economics 1302, Department of Economics, Emory University (Atlanta).
  2. Matthew J. Higgins & Daniel Levy & Andrew T. Young, 2005. "Growth and Convergence across the U.S.: Evidence from County-level Data," Emory Economics 0529, Department of Economics, Emory University (Atlanta).
  3. 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.
  4. Daniel Levy, 2005. "Investment-Saving Comovement under Endogenous Fiscal Policy," International Finance 0505008, EconWPA.
  5. 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.
  6. 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.
  7. Aleksander Aristovnik, 2005. "Twin Deficits Hypothesis And Horioka-Feldstein Puzzle In Transition Economies," International Finance 0510020, EconWPA.

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