Does Accounting for Foreign Capital Flows help to solve the Feldstein and Horioka Puzzle? The Case of Norway

Abstract

A new proxy variable for the investment part of the initial Feldstein and Horioka model is proposed. We denominate it 'modified gross fixed capital formation'. It is derived by subtracting the imports of fixed assets included in an economy's gross fixed capital formation from the gross fixed capital formation itself. This way, the exclusively domestic part of an economy's investment is isolated. Applying it in the case of Norway, the aforementioned approach significantly reduces or even eliminates the high autocorrelation inherent in the initial Feldstein and Horioka model specification. Norway appears to be characterized by a high degree of international capital mobility.