The Open-Economy Representative Agent Model

This chapter addresses the Achilles’ heel of the representative agent model: the open economy. The first section discusses the issue of goods aggregation in an open economy. The second section shows that, in a small open economy, the representative agent model requires ad hoc assumptions for stationary equilibrium. The third section analyzes the model when the rate of time preference is variable. The fourth section presents the model in which the interest rate includes a risk premium. The fifth and final section presents a small open economy representative agent model with complete financial markets and derives the investment–saving curve for such an economy.