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Lucas paradox and allocation puzzle: Is the euro area different?

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  • Herrmann, Sabine
  • Kleinert, Jörn

Abstract

This paper examines the Lucas Paradox and the Allocation Puzzle of international capital flows referring to a panel data set of EMU countries and major industrialized and emerging economies. Overall, the results do not provide evidence in favour of the Lucas Paradox and the Allocation Puzzle. Rather, in line with neoclassical expectations, net capital flows are allocated according to income and growth differentials. The 'downhill' flow of capital from rich to poor economies was particularly pronounced in intra-euro area capital flows and after the introduction of the common currency. If we control for the fact that the assumptions of the neoclassical model are not perfectly given in emerging markets, the Lucas Paradox and the Allocation Puzzle can be dismissed for these countries too. However, in periods of financial stress, the neoclassical behaviour of financial flows is to some extent dampened.

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  • Herrmann, Sabine & Kleinert, Jörn, 2014. "Lucas paradox and allocation puzzle: Is the euro area different?," Discussion Papers 06/2014, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdps:062014
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    More about this item

    Keywords

    Financial integration; International Capital Flows; European Monetary Union;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O57 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Comparative Studies of Countries

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