Abstract
This paper discusses the resurgence of the Feldstein–Horioka puzzle after the global financial crisis within the European space. Revisiting the theory of intertemporal choice, this paper suggests that the deterioration of macroeconomic fundamentals that favor capital flows from richer to poorer economies can lead investment and savings to correlate across countries even without frictions to capital mobility. I test this hypothesis against a data set of 12 European economies spanning since the inception of the Maastricht treaty and ending immediately before the start of the Covid-19 pandemic. I find that the investment-savings correlation is generally low both across and within open economies, aligning with the theoretical stylized fact. However, this can be jeopardized when low-income economies accumulate large net stocks of foreign liabilities coupled with sluggish prospects for productivity growth. Ultimately, if investment and savings are not managed in line with macro fundamentals, foreign investors eventually impose a premium on new liabilities, raising the cost of financing investment with foreign funds and leading the correlation between investment and savings to rise both across and within countries.
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More From: Journal of International Financial Markets, Institutions & Money
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