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Is the Feldstein-Horioka Puzzle Really a Puzzle?

  • Daniel Levy

    (Bar-Ilan & Emory)

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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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
Contact details of provider: Web page: http://128.118.178.162

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  1. 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.
  2. Jeffrey A. Frankel, 1991. "Quantifying International Capital Mobility in the 1980s," NBER Chapters, in: National Saving and Economic Performance, pages 227-270 National Bureau of Economic Research, Inc.
  3. Jeffrey A. Frankel and Alan T. MacArthur., 1987. "Political vs. Currency Premia in International Real Interest Differentials: A Study of Forward Rates for 24 Countries," Economics Working Papers 8762, University of California at Berkeley.
  4. Baxter, M. & Crucini, M.J., 1990. "Explaining Saving/Investment Correlation," RCER Working Papers 224, University of Rochester - Center for Economic Research (RCER).
  5. Barro, Robert J & Mankiw, N Gregory & Sala-i-Martin, Xavier, 1995. "Capital Mobility in Neoclassical Models of Growth," American Economic Review, American Economic Association, vol. 85(1), pages 103-15, March.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. 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.
  11. B. Douglas Bernheim & John B. Shoven, 1991. "National Saving and Economic Performance," NBER Books, National Bureau of Economic Research, Inc, number bern91-2, December.
  12. Miller, Stephen M., 1988. "Are saving and investment co-integrated?," Economics Letters, Elsevier, vol. 27(1), pages 31-34.
  13. Levy, D., 1990. "Investment-Saving Comovement, Capital Mobility, And Fiscal Policy," Papers 90-91-04, California Irvine - School of Social Sciences.
  14. Sachsida, Adolfo & Caetano, Marcelo Abi-Ramia, 2000. "The Feldstein-Horioka puzzle revisited," Economics Letters, Elsevier, vol. 68(1), pages 85-88, July.
  15. 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.).
  16. Daniel Levy, 1995. "Investment-saving comovement under endogenous fiscal policy," Open Economies Review, Springer, vol. 6(3), pages 237-254, July.
  17. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  18. 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.
  19. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
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