A Time‐series Approach to the Feldstein–Horioka Puzzle with Panel Data from the OECD Countries

• Author: Saten Kumar,B. Bhaskara Rao
• Published date: 01 March 2011
• Date: 01 March 2011
• DOI: http://doi.org/10.1111/j.1467-9701.2010.01326.x

A Time-series Approach to the

Feldstein–Horioka Puzzle with

Panel Data from the OECD

Countries

Saten Kumar

1

and B. Bhaskara Rao

2

1

Auckland University of Technology, Auckland and

2

University of Western Sydney, Sydney

1. INTRODUCTION

THE high correlation between domestic savings and investment is well

known as the Feldstein–Horioka puzzle (henceforth FHP). It started with

Feldstein and Horioka (1980, henceforth FH) where they have shown with the

cross-section data of 16 OECD countries for the period 1960–74, that invest-

ment and saving ratios are highly correlated. Therefore, they argued that

domestic saving is the main source of funds for investment, which in turn

implies, according to them, that international capital mobility is low. However,

this implication as evidence against capital mobility was questioned by some

authors. Jansen (1996, 1998), Coakley and Kulasi (1997) and Pelgrin and

Schich (2004) interpret the close long-run relationship between the investment

and saving ratios as a solvency condition that must be satisfied and not as evi-

dence against international capital mobility. Byrne et al. (2009) have argued

that this correlation could be due to common global shocks and therefore it

may not be interpreted as evidence against capital mobility. Nevertheless, we

take the view of many that the FHP is a simple and an indirect test on the

extent to which capital is mobile across countries. If tested for structural breaks

it can also give an indication about changes in capital mobility. Capital mobil-

ity, in its own right, is important because it has implications for single currency

debates, tax policies on capital and saving, whether growth is constrained by

We are grateful to a referee of this journal for many constructive suggestions. However, remaining

errors are our responsibility.

The World Economy (2011)

doi: 10.1111/j.1467-9701.2010.01326.x

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The World Economy