Looking behind the facade of the Feldstein-Horioka puzzle

Jan Acedański and Marek Dąbrowski

MPRA Paper from University Library of Munich, Germany

Abstract: This paper provides novel insights into the Feldstein-Horioka puzzle. The famous finding of Feldstein and Horioka (1980) is that despite perfect international capital mobility, domestic saving does not flow among countries to equalise yields but instead is tightly related to domestic investment. We observe that the link between empirical results and their theoretical foundations rarely goes beyond the saving-investment identity, and the research is dominated by empirical approaches coupled with advanced econometric techniques. This paper harnesses open economy macroeconomic models to demonstrate that the saving-retention coefficient informs about the relative importance of shocks rather than the degree of international capital mobility. Using the Monte Carlo experiments and the open economy RBC model, we show that the dominance of spending and foreign shocks moves the distribution of the estimated coefficient towards zero, whereas the prevalence of investment (productivity) shocks shifts the distribution towards one. On the empirical side, we proxy shocks to saving with debt and current account surprises constructed from the IMF's forecasts and employ them to instrument the saving ratio. Using the CCE estimator, we uncover that, in line with the theoretical framework, the saving-retention coefficient is significantly lower in the instrumental variable regressions than in the regressions without instruments. Finally, we replicate the puzzling finding that investment-saving correlations are higher in advanced economies than in emerging market economies only in a few regressions without instrumentation and demonstrate that the difference disappears when the endogeneity of the saving rate is adequately remedied.

Keywords: Feldstein-Horioka puzzle; capital mobility; capital flows; open economy macroeconomics; saving and investment (search for similar items in EconPapers)
JEL-codes: E44 F32 F41 G15 (search for similar items in EconPapers)
Date: 2024-11-27
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-opm
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