The savings and investment relationship: The Feldstein-Horioka puzzle revisited

This paper revisits the Feldstein Horioka (FH) puzzle by estimating a time varying parameter model through Kalman filtering. The paper investigated the existence of savings and investment relationship for 22 OECD countries. We found evidence that the time varying saving retention coefficient has gradually declined since mid 70's for most of the countries in our sample. Average time varying saving retention coefficient for the entire sample also showed steady decline as well. The degree of capital mobility is increasing as the world financial markets are becoming increasingly integrated over time. Therefore, the savings and investment relationship will go through a dynamic process. The current study tries to capture this dynamic relationship between savings and investment using a state-space model.