Productivity Shocks, Learning, and Open Economy Dynamics

I study the implications of productivity shocks in a model where agents observe the aggregate level of productivity but not its permanent and transitory components separately. The model`s predictions under learning differ substantially from those under full information and are in line with several empirical findings: (i) the response of investment to a permanent shock is sluggish and peaks with delay; (ii) permanent shocks generate positive rather than negative savings on impact; and (iii) saving and investment are highly correlated despite the assumption of capital mobility. Unlike other standard explanations of the Feldstein-Horioka puzzle, learning induces high correlations irrespective of the assumed persistence of shocks