Is the Feldstein–Horioka Puzzle History?

Abstract

A country's intertemporal budget constraint implies current account stationarity or that its saving and investment rates should cointegrate. However, such behaviour may not pertain in finite sample spans where the current account could be subject to persistent shocks. Accordingly, this paper reconsiders the Feldstein–Horioka puzzle for a panel of 12 OECD economies 1980I–2000IV using a mean group regression approach that is robust to persistent innovations and accounts for country heterogeneity and cross‐sectional dependence. The mean group estimates are notably smaller than that from the conventional cross‐section estimator and are statistically insignificant. Our findings support the view that capital is highly mobile in the long run for OECD economies despite persistence in the current account.