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Resolving the Feldstein-Horioka Puzzle

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Abstract

This paper attempts to resolve the Feldstein-Horioka puzzle represented by the contradiction between the casual observation that capital mobility has reached a high level and the empirical evidence indicating the contrary by showing high saving ¬investment correlations. Three lines of enquiry are followed, the first of which is to rethink the Feldstein-Horioka methodology from econometric and theoretical perspectives. The second line of enquiry is to evaluate the appropriateness of the saving-investment correlation as a measurement criterion, and it is argued that international parity conditions are better criteria. The third line of enquiry is to investigate the mobility of different kinds of capital. It is concluded that international parity conditions, viewed and estimated properly, provide strong evidence for capital mobility, and hence the puzzle is resolved.

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