Domestic Saving and Investment Revised: Can the Feldstein-Horioka Equation be Used for Policy Analysis?

Based on the relation between investment and domestic saving proposed by Feldsteinand Horioka (1980) to verify capital mobility, this study performs some exogeneitytests in order to determine the capacity of the FH equation of supporting andimplementing economic policies in Brazil. We then use the result of weak exogeneitytest to identify a structural vector autoregressive (SVAR) involving investment andsaving in order to evaluate the effect of exogenous shocks through impulse responsefunctions (IRFs) on both variables. The main findings of this paper are: a) theelasticity of domestic saving estimated using appropriate methods points out to highcapital mobility for Brazil; b) domestic saving is weakly exogenous in the FHequation; c) domestic saving is not strongly exogenous, therefore this equation shouldnot be used to make forecasts for the Brazilian economy; d) superexogeneity isaccepted for domestic saving, meaning that Lucas? criticism does not apply; and e)the IRFs showed that investment is sensitive to contemporaneous innovation onsaving and this effect lasts for a long time. Regarding to domestic saving, the responseof this variable to a non-expected shock on investment has a more is more complicatedescription. Initially domestic saving goes down. After some lags this movementchanges and domestic saving begins to react positively to the shock.