Abstract
This chapter addresses the Achilles’ heel of the representative agent model: the open economy. Section 2.1 discusses the issue of goods aggregation in an open economy. Section 2.2 shows that, in a small open economy, the representative agent model requires ad hoc assumptions for a stationary equilibrium. Section 2.3 analyzes the model when the rate of time preference is variable. Section 2.4 presents the model in which the interest rate carries a risk premium. Section 2.5 shows the calculation of the IS curve for a small open economy from a representative agent model with complete financial markets.
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