The Feldstein-Horioka puzzle and exchange rate regimes: Evidence from cointegration tests
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AbstractMany economists specialized in international finance claim that international capital markets are highly integrated (at least during the flexible exchange rate era). The main consequence of the above claim is that there is no longer any close relationship between investment and savings decisions. In other words, the close link between savings and investment ceases to exist under perfect capital mobility. Therefore, we construct a general equilibrium optimization model that is capable of generating artificial (model) data for savings and investment. Then, using the methodology of cointegration testing on these artificial data, we test whether there exists or not any link between savings and investment. The test is implemented between two different exchange rate regimes, that is, that of the Bretton Woods and that of the floating or flexible exchange rate regime. The results from the empirical analysis provide support for integrated capital markets over the second exchange rate era in the case of the United States of America.
JournalJournal of Policy Modeling
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