When saving meets investment: How shocks shape the Feldstein–Horioka puzzle

This study offers a new perspective on the Feldstein–Horioka puzzle by highlighting the central role of macroeconomic shocks in shaping the time-series correlation between investment and saving. We argue that the coefficient reflects the relative importance of shocks and responses of investment and saving to them rather than the level of international capital mobility. We develop a novel decomposition of the saving-retention coefficient into shock-specific components for a class of linear dynamic models and apply it to open-economy DSGE models estimated for nearly 60 countries. We show that domestic demand shocks tend to raise the saving-retention coefficient because they have similar effects on investment and saving. In contrast, foreign shocks typically reduce the coefficient but contribute little to its overall value. Furthermore, the dissimilar responses of investment and saving to technology shocks, especially permanent ones, emerge as the primary source of the higher coefficient values observed in advanced economies compared to emerging markets. Overall, the analysis shows that the benefits countries can derive from capital flow liberalization largely depend on the structure of the shocks they experience.