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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Mon, 29 Aug 2005

Is the Feldstein Horioka puzzle dead or dying?

In today’s Financial Times, Martin Wolf writes that

“The principal determinant of the pattern of capital flows is, it turns out, divergent savings rates. ... because investment rates were closer together than savings rates, the world's capital exporters were countries with high savings rates and the importers were ones with low savings rates.” (Martin Wolf, “Capital flow must change course”, Financial Times, August 29, 2005.)

Does this mean that one of the oldest puzzles of international financial economics, the Feldstein Horioka puzzle is dead or dying? Feldstein and Horioka showed that the cross sectional regression coefficient of investment rates on savings rates was close to unity. (Feldstein, M. and C. Horioka, 1980, “Domestic savings and international capital flows”, Economic Journal, 90, 314-329). This coefficient has fallen since then. Obstfeld and Rogoff noted that the regression coefficient had fallen to 0.60 for the early and mid 1990s as opposed to the 0.89 obtained by Feldstein and Horioka for the 1960s and early 1970s (Obstfeld, M. and K. Rogoff, 2000, “The six major puzzles in international macroeconomics: Is there a common cause?”, NBER Working Paper 7777).

Perhaps, freer capital markets are destroying what is left of the puzzle?

Posted at 11:16 on Mon, 29 Aug 2005     3 comments     permanent link


Ajay Shah wrote on Thu, 15 Dec 2005 11:07

Re: Is the Feldstein Horioka puzzle dead or dying?

He says that if you do weighted estimation, the puzzle is still with us.

Prof. Jayanth R. Varma wrote on Tue, 20 Dec 2005 16:09

Re: Is the Feldstein Horioka puzzle dead or dying?

Alan Greenspan's speech earlier this month in London ( also dwells on this theme to defend the US current account deficit:

"The rise of the U.S. current account deficit over the past decade appears to have coincided with a pronounced new phase of globalization that is characterized by ... the decline in what economists call home bias. In brief, home bias is the parochial tendency of persons, though faced with comparable or superior foreign opportunities, to invest domestic savings in the home country. The decline in home bias is reflected in savers increasingly reaching across national borders to invest in foreign assets ... Accordingly, it is tempting to conclude that the U.S. current account deficit is essentially a byproduct of long-term secular forces, and thus is largely benign."