Feldstein-Horioka puzzle

Feldstein-Horioka puzzle

The Feldstein-Horioka puzzle is a widely-discussed problem in macroeconomics and international finance, first documented by Martin Feldstein and Charles Horioka in an 1980 paper.citation | last1 = Feldstein | first1 = Martin | last2 = Horioka | first2 = Charles | year=1980 |title= Domestic Saving and International Capital Flows | journal = Economic Journal | volume = 90 | pages = 314-329]

FH argued that if there is perfect K mobility, we should observe low correlation between domestic I and S. Investors in one country do not need the funds from domestic savers and can borrow from international markets at world rates. By the same token, savers can lend to foreign investor the entirety of the domestic savings. According to standard economic theory, in the absence of regulation in international financial markets, the savings of any country would flow to countries with the most productive investment opportunities. Therefore, domestic saving rates would be uncorrelated with domestic investment rates. This is the same fundamental insight which underlies several other results in economics like the Fisher separation theorem.

If the capital flows between OECD countries are reasonably free, this should hold true for domestic saving and investment rates for those countries. Feldstein and Horioka observed that, for OECD countries, domestic savings rates and domestic investment rates are, instead, highly correlated, in contrast to standard economic theory.

Maurice Obstfeld and Kenneth Rogoff identify this as one of the six major puzzles in international economics.Citation
last= Obsfeld
first= Maurice
last2= Rogoff
first2= Kenneth
year= 2000
editor-last= Bernanke
editor-first= Ben
editor2-last= Rogoff
editor2-first= Kenneth
contribution= The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?
title=NBER Macroeconomics Annual 2000
volume = 15
pages = 339-390
publisher= The MIT Press
isbn = 0-262-02503-5] The others are the home bias in trade puzzle, the equity home bias puzzle, the consumption correlations puzzle, the purchasing power and exchange rate disconnect puzzle, and the Baxter-Stockman neutrality of exchange rate regime puzzle.

References


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