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Revisit Feldstein-Horioka puzzle: evidence from Malaysia (1960-2015)

Razak, Lutfi Abdul and Masih, Mansur (2017): Revisit Feldstein-Horioka puzzle: evidence from Malaysia (1960-2015).

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This paper revisits the Feldstein-Horioka puzzle – the mother of all puzzles – to uncover whether there exists a long-run relationship between domestic investment and domestic savings for the case of Malaysia. This is a long-standing empirical puzzle in macroeconomics which contradicts economic theory: for open economies, savings should be able to flow to where investment returns are most attractive, and hence there should be no correlation between investment and savings. One plausible reason put forth in the literature as an explanation for the puzzle is the reduction in trade frictions. As trade frictions are reduced, capital becomes more mobile, which in turn would mitigate the Feldstein-Horioka puzzle. Using an ARDL framework, we seek to investigate whether trade openness, as a proxy for reduced trade frictions, can help explain the long-run relationship between savings and investment. Although we discover mixed evidence with regards to the role of trade openness, we find that more importantly, the results tend to indicate the presence of possible structural break. Nevertheless, the results from our paper imply that policymakers can set the savings rate as an intermediate target to affect investment and real income.

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