The Feldstein-Horioka puzzle: revisited
The high association between national savings and investment rates across OECD countries is one of the best-established facts in international economics. The basis for this fact was Feldstein and Horioka's cross section study in 1980. Feldstein and Horioka found that saving and investment in OECD countries were highly correlated. They interpreted this result as perfect capital immobility. They further stated that with perfect capital mobility "there should be no relation between domestic savings and domestic investment: saving in each county responds to the worldwide opportunities for investment while investment in that country is financed by the worldwide pool of capital". There is no a priori reason to expect saving and investment to be correlated across countries, as investment rates depend on the expected real rates of return, while saving rates depend upon demographic and cultural elements and on the distribution of income. The Feldstein-Horioka interpretation was controversial since it appeared. It was widely accepted that the financial markets were integrated. The active Eurocurrency markets and the existence of covered interest parity across countries contributed to it. The speed with which the stock market crash of 1987 was transmitted internationally, the large flows of portfolio and direct investment to the rapidly growing markets of East Asia and the ease with which large balance of payments deficits could be financed provided more evidence towards the opposite direction.