DP4610 The Feldstein-Horioka Fact

Author(s): Domenico Giannone , Michele Lenza

Publication Date: September 2004

Keyword(s): saving-correlation , capital mobility , international co-movement , dynamic factor model

JEL(s): C23 , F32 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4610.asp

This Paper shows that general equilibrium effects can partly rationalize the high correlation between saving and investment observed in OECD countries. We introduce a novel factor augmented panel regression to control for general equilibrium effects where global shocks are allowed to affect each country with specific magnitude and lag structure. We show that the homogeneity restriction on the propagation of global shocks across countries is rejected by the data and biases the saving-retention coefficient estimated in previous studies. By relaxing this assumption, the saving-retention coefficient remains high in the 70s but decreases considerably over time becoming very small in the last two decades. This finding is explained by the increased capital mobility in OECD countries.