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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.

Suggested Citation

  • Daniel Levy, 2004. "Is the Feldstein-Horioka Puzzle Really a Puzzle?," International Finance 0402002, EconWPA, revised 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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    References listed on IDEAS

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    1. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 39(3), pages 106-135.
    2. Martin Feldstein, 1991. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Chapters,in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 331-353 National Bureau of Economic Research, Inc.
    3. 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 103-115, March.
    4. Baxter, Marianne & Crucini, Mario J, 1993. "Explaining Saving-Investment Correlations," American Economic Review, American Economic Association, vol. 83(3), pages 416-436, June.
    5. Sachsida, Adolfo & Caetano, Marcelo Abi-Ramia, 2000. "The Feldstein-Horioka puzzle revisited," Economics Letters, Elsevier, vol. 68(1), pages 85-88, July.
    6. Daniel Levy, 1995. "Investment-saving comovement under endogenous fiscal policy," Open Economies Review, Springer, vol. 6(3), pages 237-254, July.
    7. 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.
    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 107-128, January.
    9. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
    10. Miller, Stephen M., 1988. "Are saving and investment co-integrated?," Economics Letters, Elsevier, vol. 27(1), pages 31-34.
    11. 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.
    12. Levy, D., 1990. "Investment-Saving Comovement, Capital Mobility, And Fiscal Policy," Papers 90-91-04, California Irvine - School of Social Sciences.
    13. Sinn, Stefan, 1992. "Saving-Investment Correlations and Capital Mobility: On the Evidence from Annual Data," Economic Journal, Royal Economic Society, vol. 102(414), pages 1162-1170, September.
    14. Frankel, Jeffrey A. & MacArthur, Alan T., 1988. "Political vs. currency premia in international real interest differentials : A study of forward rates for 24 countries," European Economic Review, Elsevier, vol. 32(5), pages 1083-1114, June.
    15. 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.
    16. 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.).
    17. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    18. B. Douglas Bernheim & John B. Shoven, 1991. "National Saving and Economic Performance," NBER Books, National Bureau of Economic Research, Inc, number bern91-2, January.
    19. James G. MacKinnon, 1990. "Critical Values for Cointegration Tests," Working Papers 1227, Queen's University, Department of Economics.
    20. 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.
    21. Gulley, O. David, 1992. "Are saving and investment cointegrated? : Another look at the data," Economics Letters, Elsevier, vol. 39(1), pages 55-58, May.
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    Citations

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    Cited by:

    1. Litsios, Ioannis & Pilbeam, Keith, 2017. "An empirical analysis of the nexus between investment, fiscal balances and current account balances in Greece, Portugal and Spain," Economic Modelling, Elsevier, vol. 63(C), pages 143-152.
    2. Young, Andrew T. & Higgins, Matthew J. & Levy, Daniel, 2013. "Heterogeneous convergence," Economics Letters, Elsevier, vol. 120(2), pages 238-241.
    3. 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, Faculty of Economics, University of Coimbra.
    4. Daniel Levy, 1995. "Investment-saving comovement under endogenous fiscal policy," Open Economies Review, Springer, pages 237-254.
    5. 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.
    6. Matthew Higgins & Daniel Levy & Andrew Young, 2003. "Growth and Convergence across the U.S.: Evidence from County-level Data," Emory Economics 0306, Department of Economics, Emory University (Atlanta).
    7. 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.
    8. Aleksander Aristovnik, 2005. "Twin Deficits Hypothesis And Horioka-Feldstein Puzzle In Transition Economies," International Finance 0510020, EconWPA.

    More about this item

    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;

    JEL classification:

    • F02 - International Economics - - General - - - International Economic Order and 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General

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