Feldstein Horioka Research Articles

Why the Feldstein–Horioka “puzzle” remains unsolved

AbstractWe argue that the 40‐year‐old Feldstein–Horioka “puzzle” should have never been labeled as such. We discuss two problems with the literature. First, we show that the series of investment and saving rates typically used in empirical exercises to test the Feldstein–Horioka thesis are not appropriate. The correct series to properly test it are not collected. Second, we show that the Feldstein–Horioka regression is not a model in the econometric sense, that is, an equation with a proper error term (a random variable). The reason is that by adding the capital account to their regression, one gets the accounting identity that relates the capital account, domestic investment, and domestic saving. This implies that the estimate of the coefficient of the saving rate in the Feldstein–Horioka regression can be thought of as a biased estimate of the same coefficient in the accounting identity, where it has a value of 1. Because the omitted variable is known, we call it pseudo bias. Given that this (pseudo) bias is known to be negative and less than 1 in absolute terms, it should come as no surprise that the Feldstein–Horioka regression yields a coefficient between 0 and 1.

Macro fundamentals and the resurgence of the Feldstein–Horioka puzzle in Europe

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.

The Feldstein–Horioka Puzzle or Paradox after 44 years: a fallacy of composition

AbstractThe finding of Feldstein and Horioka (1980) that domestic saving and domestic investment are highly correlated across countries despite the rapid globalization and liberalization of financial markets in recent decades has been regarded as a Puzzle or Paradox. However, in this paper, we show that countries as a whole may not be able to transfer their capital abroad and that the Feldstein–Horioka Finding of domestic saving and domestic investment being highly correlated across countries may arise even if there are no frictions in financial markets and even if individual investors can freely transfer their capital abroad if there are frictions in goods markets such as transport costs, tariffs, nontariff barriers, the cost of regulatory compliance, etc. In fact, there is evidence that frictions in goods markets are a more serious impediment to countries as a whole being able to transfer their capital abroad than frictions in financial markets, especially in the short run.

AN ASSESSMENT OF THE FELDSTEIN–HORIOKA PUZZLE FOR INDIA: A MARKOV REGIME SWITCHING APPROACH

The study aims to examine the Feldstein–Horioka puzzle in the Indian context during 2002Q2 to 2019Q4 to unearth nonlinear patterns in the data. Findings from an augmented Markov regime-switching model reveal two distinct, yet random regimes for correlations between savings and investment-GDP ratios, with higher correlation between the variables persisting for a longer duration. In the low correlation regime, trade-related factors, policy uncertainty and global shocks have a significant impact on the correlation. Fiscal shocks and trade costs explain high correlations in regime 2, while global shocks act to decrease the correlation in this regime. The high correlation regime dominates the study period and indicates that the Feldstein–Horioka puzzle of limited capital mobility persists in India. Economic agents appear to respond rapidly to changing domestic and global policy conditions, besides being affected by incomplete integration of goods markets, explaining the pattern of correlations.

EXPLORING INDIA’S ECONOMIC SCENARIO THROUGH THE LENS OF FELDSTEIN HORIOKA PUZZLE

The Feldstein Horioka Puzzle has been a subject of extensive research, with various studies offering conflicting perspectives on its validity. The puzzle focuses on the relationship between saving and investment and whether the relationship holds true at the national level. The puzzle pertains to the persistent correlation between savings and investment, implying that countries with higher savings rates should also exhibit higher investment rates, in opposition to what conventional economic models predict. In the case of India, the Feldstein Horioka Puzzle has yielded diverse conclusions. Annual data from 1970 to 2021 has been used in the study to examine the validity of the Feldstein Horioka Puzzle in India. To confirm the long-term association between saving and investment, it is crucial to consider the cointegration test results. The results of the study KEYWORDS: Feldstein-Horioka Puzzle, saving, investment, fixed exchange rate, cointegration

Re-estimation of the savings retention coefficient in OECD countries: a new measure of home country bias

The recent home bias is primarily related to the equity bias as measured by the international capital asset pricing model (CAPM); this measure has declined over the past two decades amid financial globalization, but remains high in most developed countries. The key to understanding this puzzling phenomenon lies in how accurately this indicator can be predicted. In this paper, we propose to use the savings retention coefficient estimated by the Feldstein–Horioka (F–H) regression as a cross-country measure of home bias. We re-estimate the savings retention coefficient based on an estimation model in which the FH regression is embedded in the model derived from Tobin's q-theory of saddle-road dynamics of investment under convex adjustment costs. We then use dynamic panel estimation to estimate the new measure in OECD countries. The main empirical results are as follows. The new measure of home country bias, such as the equity bias measure, declined steadily until 2008, but recovered to the level of the 60 s and 70 s after the 2008 financial crisis. Interestingly, people expected home country bias to be very high after the financial crisis, but in fact it simply returned to its previous level.

Schumpeter’s insights for monetary macroeconomics and the theory of financial crises

Abstract The purpose of this paper is to show that Schumpeter can offer important insights for macroeconomic theory today. This applies especially to his distinction between a “real analysis” and a “monetary analysis,” as he calls it, and its implications for monetary macroeconomics, especially the theories of financial crises at the national and the global levels. The main problem of the “real analysis” is the identity of the financial sphere with the real sphere. The consequence of this narrow view is the inability to understand the dynamics of a monetary economy, which is the main cause for financial crises. The flaws of the real analysis manifest themselves also at the global level. The Feldstein–Horioka puzzle and the Lucas paradox are obvious “anomalies” of this paradigm. Models based on the real analysis are unable to explain the extent and even direction of international capital flows. Thus, the economics profession was unable to see the risks that were accumulating in the international financial system before the outbreak of the Great Financial Crisis.

The Feldstein-Horioka Puzzle in India: Some Asymmetric Evidence

This paper examines the Feldstein-Horioka (FH) hypothesis for India using the non-linear autoregressive distributed lag model and the Hatemi-J asymmetric causality test. The empirical findings show: (1) the validity of the FH puzzle for the Indian economy, which implies the presence of imperfect capital mobility; (2) that positive (negative) saving causes positive (negative) investment; and (3) negative (positive) saving does not cause positive (negative) investment.

G20 Ülkeleri İçin Feldstein-Horioka Bulmacasının Geçerliliğinin Panel Veri Yöntemi ile Sınanması

Yurt içi ve yurt dışı tasarruflar, gelişmiş veya gelişmekte olan ülkelerde, ekonomik büyümenin ve kalkınmanın temeli olarak görülmektedir. Özellikle 1980’lerden bu yana artan sermaye hareketliliği ile birlikte bu alanda birçok çalışma yapılmıştır. Son dönemlerde sermaye hareketliliği, yurt içi tasarruf ve yatırım arasında güçlü bir ilişkinin varlığını varsayan Feldstein-Horioka (FH) bulmacası temelinde sıkça tartışılmaktadır. Bu çalışmanın amacı 1995-2020 döneminde G20 ülkeleri için, Feldstein-Horioka bulmacasının geçerliliğini incelemektir. Çalışmada kullanılan yurt içi tasarrufların ve yurt içi yatırımların gayri safi yurt içi hasılaya oranı değişkenleri, Dünya Bankasının Gelişmişlik Göstergeleri veri tabanından elde edilmiştir. Bu çalışmada, mevcut literatürün metodolojik sorunları da göz önüne alınarak yenilikçi veri analitik prosedürleri kullanılmıştır. Bu bağlamda, mevcut çalışma, panel verilerin yatay kesit bağımlılığını ve heterojen yapısını dikkate almaktadır. Genişletilmiş Ortalama Grup (AMG) tahmincisi ve Ortak Korelasyonlu Etkiler Ortalama Grubu (CCEMG) tahmin edicilerinden elde edilen FH panel katsayıları sırasıyla 0,261 ve 0,301'dir. Genel sonuçlar, FH bulmacasının G20 ülkeleri için geçerli olmadığını göstermektedir. Bu çalışma, tasarruf ve yatırım ilişkisi temelinde gelecekteki çalışmalara yönelik önemli politika ve uygulama çıkarımları sunmaktadır.

Savings-investment and the Current Account: More Measurement Error than Identity

Econometric estimates of the determinants of current account (im)balances invariably start with the accounting “identity” that the current account is equal to the difference between (national) savings and (national) investment. However, this accounting relationship does not hold in the official data. The measurement errors are small but still significant for G-7 countries, and for other countries, these errors are often large (> 5% GDP), especially for less-developed countries. Larger samples imply thus also larger measurement errors. Moreover, there are important differences among the data that different widely used international sources such as the World Bank or the IMF have reported. This should be defined in full here. We illustrate the importance of these measurement errors in two ways: (1) the simple correlations between savings and investment often used to gauge capital mobility (the Feldstein–Horioka (1980) paradox) appear to be very different when different data sources are used, and (2) in a standard model for current account determination, using savings minus investment instead of the current account leads to some significantly different results, regarding the significance of the level of GDP per capita or banking crisis.

TÜRKİYE VE ORTA ASYA TÜRK CUMHURİYETLERİNDE FELDSTEIN-HORIOKA BULMACASININ TEST EDİLMESİ

Yatırım ve tasarruf ilişkisi literatürde ampirik olarak sıkça sınanmış olup, bu ilişkinin düzeyi ve ekonomik yapıdaki etkisine yönelik birçok hipotez ortaya atılmıştır. Feldstein-Horioka bulmacası da bu hipotezlerden biridir. Bu çalışmada Türkiye ve Türk cumhuriyetlerinden Azerbaycan, Kazakistan, Kırgızistan ve Tacikistan ekonomilerinde Feldstein-Horioka bulmacasının geçerliliği test edilmiştir. 2002-2018 dönemine ait yıllık veriler kullanılarak yapılan çalışmada analiz yöntemi olarak yatay kesit bağımlılığı, birim kök, parametre tahminleri ve nedensellik testleri uygulanmıştır. Parametre tahminlerinde Feldstein-Horioka bulmacasının yalnızca Tacikistan ve Kırgızistan’da geçerli olduğu sonucuna ulaşılmıştır. Nedensellik testlerinde panelin tamamı için yurtiçi tasarruflardan yatırımlara doğru kısa ve uzun dönemde nedensellik tespit edilmiştir. Ülke bazında yapılan analizlerde ise yurtiçi tasarruflardan yatırımlara doğru nedensellik ilişkisinin sadece Tacikistan ve Türkiye için söz konusu olduğu görülmektedir.

The Feldstein–Horioka hypothesis for African countries: Evidence from recent panel error‐correction modelling

AbstractThis paper, by applying the recent panel data error‐correction modelling developed by Gengenbach et al., Panel error correction testing with global stochastic trends, 2008 University of Maastricht, Working Paper, RM/08/051:1–51 and Gengenbach et al., Journal of Applied Econometrics, 2016, 31, 982–1004 tests the validity of the Feldstein–Horioka puzzle (1980) in a panel of 27 African countries for the period 1965–2015. Unlike the existing studies in the literature, this paper, for the first time, addresses several important panel data econometric issues such as slope heterogeneity, cross‐section dependence, unobservable common factors, non‐stationarity and endogeneity that would yield inconsistent and biased estimates of the parameters of interest. Unlike the previous residual‐based error‐correction modelling that has low power, the Gengenbach et al., Panel error correction testing with global stochastic trends, 2008, University of Maastricht, Working Paper, RM/08/051:1–51 and Gengenbach et al., Journal of Applied Econometrics, 2016, 31, 982–1004 estimator explicitly considers structural dynamics in modelling a cointegrated panel that allows for the presence of non‐stationary unobserved common factors. As the GUW modelling depends on the Pesaran Common Correlated Effects Mean Group Estimator (CCEMG; 2006) and the Chudik and Pesaran Dynamic Common Correlated Effects Mean Group Estimator (DCCEMG; 2015), we report the results based on these estimators. The econometric exercises performed in the paper show that slope heterogeneity; cross‐section dependence and non‐stationarity are present in the panel data sample used in the estimation. Estimations yield a relatively low magnitude of the savings retention coefficient for the panel members included in the study with a negative error‐correction term that is statistically significant at the individual and panel levels. The empirical evidence rejects the presence of the Feldstein–Horioka puzzle in the panel of 27 African countries studied.

ANALYSIS OF TWIN DEFICIT PROBLEM AND FELDSTEIN-HORIOKA HYPOTHESIS: AN EMPIRICAL INVESTIGATION FOR OECD COUNTRIES

The twin deficit hypothesis suggests that there is a relationship between the budget deficit and the current account deficit. The traditional Keynesian Approach emphasizes that budget deficits resulted in the current account deficit. On the other hand, the Ricardian Equivalence Approach argues that there is no relationship between budget deficits and current account deficit. In this study, the validity of the twin deficit hypothesis and Feldstein Horioka (1980) hypothesis is analyzed using both the Breaking Periods of the Westerlund-Edgerton Breaking Cointegration Test (2008) and the Dumitrescu & Hurlin (2012) Panel Causality Test. According to the cointegration and causality analyzes, it is concluded that there is a long-term relationship between budget deficits and current account deficits. This result supports the Traditional Keynesian Approach. Furthermore, it is seen that there is a two-way relationship between budget deficits and current account deficits. Long term coefficients were obtained by using the AMG test. When the panel coefficient results are considered, it is seen that the twin deficit hypothesis is valid, but the results are obtained contrary to the analysis found by Feldstein Horioka (1980). However, when the individual countries are examined, it is seen that the twin deficit hypothesis applies to some countries, and the twin divergence hypothesis applies to some other countries. Besides, it is understood that the study results do not support the Feldstein-Horioka (1980) hypothesis.

New insight into Feldstein and Horioka Paradox: Analyzing the mediating roles of globalization, urbanization, and foreign direct investment

Different dimensions abound to examine the famous Feldstein–Horioka Puzzle. However, after intense discussions of the subject matter for more than three decades, researchers are yet to reach consensus on the validity or otherwise of savings–investment relationship. In this paper, we revisited the Feldstein–Horioka saving-investment puzzle, and augment their investment equation with factors that drive capital mobility, such as globalization, foreign direct investment, and urbanization using more recent annual frequency time series data over the periods 1981–2018 in the case of Nigeria. We employed unit root test with structural breaks/regime shifts inherent in time series data and Autoregressive Distributed Lag Bounds Testing for co-integration of empirical estimates. Results show existence of a long-run equilibrium relationship among variables. Domestic savings, real income, and foreign direct investment reveal positive impact, while globalization and urbanization exhibit negative impact on domestic investment both in the short and long run. We find strong capital mobility among savings–investment relationship, thus render potential policy suggestions that would drive domestic investment and bring about sustainable economic growth in the long run.

Ricardian equivalence, Feldstein–Horioka puzzle and twin deficit hypothesis in Indian context: An empirical study

The paper investigates the twin deficit hypothesis in case of India. Furthermore, this paper examines the Ricardian equivalence hypothesis and the Feldstein‐Horioka puzzle to complement the twin deficit hypothesis. To substantiate objectives, annual time series data for the period 1970 to 2012 have been used. Time series econometrics techniques such as vector autoregressive model and auto regressive distributive lag model have been employed wherever necessary. The empirical findings suggest the rejection of twin deficit hypothesis and Feldstein‐Horioka puzzle. However, it validates the Ricardian equivalence hypothesis i.e the fiscal deficit does not affect the current account deficit. Fiscal deficit retaining strategy may not be all in controlling current account deficit, than taking wholesome strategy that includes export promotion.

Adaptive LASSO for selecting Fourier coefficients in a functional smooth time-varying cointegrating regression: An application to the Feldstein–Horioka puzzle

This paper proposes a simple routine to select the specification of a time-varying cointegration model based on a combination of polynomials. Whereas information criteria or approaches based on sequential general to specific testing procedures are commonly used for that issue, to our knowledge, there exists no formal proof of the consistency of these selection methods for these models. In addition, these latter strategies imply exhaustive searches which may be computationally cumbersome. We suggest to use a widespread technique in machine learning, a LASSO-based procedure, that sets the right number of polynomials to combine for describing the time-varying dynamic in a cointegrating regression. Monte Carlo experiments show that the selection consistency of the Adaptive LASSO holds in our context. We applied the outlined methodology to the degree of capital mobility for the some European economies and we found a decline of saving retention within the last two decades.

Does the Feldstein–Horioka relationship vary with economic policy uncertainty?

ABSTRACT This research addresses the omitted-uncertainty bias and functional form misspecification problem when estimating the saving-investment relationship. We apply a semiparametric varying-coefficient cointegration approach to test for the presence of an ‘uncertainty-varying’ cointegrating relationship between savings and investment. Based on quarterly time series data for the U.S. from 1947Q1 to 2014Q4, we find that the saving-retention coefficient is a U-shaped function of economic policy uncertainty. This indicates that domestic investment is more constraint by domestic savings at very high and very low levels of uncertainty. Given the continued rise in economic policy uncertainty, our estimate predicts that domestic investment will become more constrained by domestic savings. Further sub-period analysis shows that the null hypothesis of the presence of an uncertainty-varying cointegrating relationship between savings and investment cannot be rejected in the recent sub-period of 1999Q1-2014Q4, suggesting that the U.S current account is sustainable.

(A)Symmetric effects of changes in the saving rate on the investment rate in Norway: 1830–2017

ABSTRACT In view of the Feldstein–Horioka (1980) puzzle, this study examines the relationship between the investment rate and the saving rate using annual data from Norway for 1830 to 2017. The nonlinear version of the autoregressive distributed lag (ARDL) cointegration methodology developed by Shin (2014), based on the linear ARDL bounds cointegration testing approach of Pesaran et al. (2001), is implemented. The findings show that there is a long-term cointegration relationship between the saving rate and investment rate. The nonlinear ARDL model indicates that there are short-run but no long-run asymmetric effects. It is concluded that Norway respects its intertemporal budget constraint and that international capital mobility is high.

Reexamining the National Savings-Investment Nexus Across Time and Countries

Domestic savings and investment are positively correlated across countries and through time, as Feldstein-Horioka (FH) unveiled 40 years ago. We argue that an interpretation of this correlation based on market failures is more consistent with data patterns than alternative hypotheses. Moreover, resorting to instrumental variables techniques, we conclude that the relationship is causal: an exogenous rise in savings increases investment. This result holds in the full sample of countries and for emerging and developing economies, but there is evidence that the positive association in advanced economies is due to endogeneity bias. The core of our identification strategy relies on the idea that population age structure influences savings, but not total investment directly. Specifically, we use the share of adults in the [35-49] years of age bracket as an instrument for savings. Our estimates pass weak-instruments robust inference.

Revisiting Feldstein–Horioka Puzzle: Evidence from SAARC Economies

In the macroeconomic perspective, domestic saving and investment constitute two important wheels that keep the growth process moving on towards stability. But when domestic savings tend to fly away to foreign countries for excess returns, the warranted domestic investment remains unattained thereby which impair the growth trend unless the gap is bridged by the foreign investment inflows. However, excess inflows of foreign investments may deteriorate current account balances, if not appropriately absorbed. In this pretext, this article revisited the Feldstein–Horioka puzzle with the twin-deficit hypothesis for SAARC countries. The results lend to support the validity of the twin-deficit hypothesis along with a low degree of association between domestic savings and investment in the region thereby justifying the argument that international capital movements or financial integration have increased in the post-reform era. This observation has significant policy implications for the sustained growth of the SAARC nations.