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The Solution to the Feldstein-Horioka Puzzle

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  • Horioka, Charles Yuji
  • Ford, Nicholas

Abstract

The purpose of this paper is to set out a surprisingly simple solution to the Feldstein-Horioka Puzzle or Paradox, which is that even though global financial markets appear to be integrated, levels of saving and investment are correlated across countries because financial markets cannot, by themselves, achieve net transfers of financial capital. This is because net transfers of financial capital require the integration not only of financial markets but also of goods markets and because there are substantial frictions in goods markets (e.g., transport, marketing, and distribution costs, technical standards, certification procedures, tariffs and nontariffbarriers, etc.).

Suggested Citation

  • Horioka, Charles Yuji & Ford, Nicholas, 2017. "The Solution to the Feldstein-Horioka Puzzle," AGI Working Paper Series 2017-17, Asian Growth Research Institute.
    • Handle: RePEc:agi:wpaper:00000137
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    References listed on IDEAS

    as
    1. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412, National Bureau of Economic Research, Inc.
    2. Charles Yuji Horioka & Nicholas Ford, 2017. "A possible explanation of the ‘Exchange Rate Disconnect Puzzle’: a common solution to three macroeconomic puzzles?," Applied Economics Letters, Taylor & Francis Journals, vol. 24(13), pages 918-922, July.
    3. Nicholas Ford & Charles Yuji Horioka, 2017. "The ‘real’ explanation of the Feldstein–Horioka puzzle," Applied Economics Letters, Taylor & Francis Journals, vol. 24(2), pages 95-97, January.
    4. Horioka, Charles Yuji & Ford, Nicholas, 2016. "A Possible Explanation of the 'Exchange Rate Disconnect Puzzle': A Common Solution to Three Major Macroeconomic Puzzles?," AGI Working Paper Series 2016-15, Asian Growth Research Institute.
    5. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, April.
    6. repec:bla:econom:v:44:y:1977:i:174:p:163-78 is not listed on IDEAS
    7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    8. Nicholas Ford & Charles Yuji Horioka, 2017. "The ‘real’ explanation of the PPP puzzle," Applied Economics Letters, Taylor & Francis Journals, vol. 24(5), pages 325-328, March.
    9. Eaton, Jonathan & Kortum, Samuel & Neiman, Brent, 2016. "Obstfeld and Rogoff׳s international macro puzzles: a quantitative assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 5-23.
    10. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
    11. Apergis, Nicholas & Tsoumas, Chris, 2009. "A survey of the Feldstein-Horioka puzzle: What has been done and where we stand," Research in Economics, Elsevier, vol. 63(2), pages 64-76, June.
    12. Mishkin, Frederic S, 1984. "Are Real Interest Rates Equal across Countries? An Empirical Investigation of International Parity Conditions," Journal of Finance, American Finance Association, vol. 39(5), pages 1345-1357, December.
    13. S. Young Chung & William J. Crowder, 2004. "Why Are Real Interest Rates Not Equalized Internationally?," Southern Economic Journal, John Wiley & Sons, vol. 71(2), pages 441-458, October.
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    More about this item

    Keywords

    Capital flows; capital mobility; capital transfers; Feldstein-Horioka Paradox; Feldstein-Horioka Puzzle; financial market integration; goods market integration; interest rate parity; international capital flows; international capital mobility; investment; net capital transfers; Niehans model; real interest rate parity; saving; saving-investment correlations; trade frictions; F15; F21; F32; F36; G15;
    All these keywords.

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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