Non-Stationarity and Instability in Small Open-Economy Models Even When They Are 'Closed'

Abstract

It is well-known that the small open-economy model with incomplete asset markets leads to a non-stationary (linearized) solution. This article shows that stationarity-inducing modifications, such as debt-elastic interest rates, can imply non-existence of the rational expectations equilibrium. Alternative specifications are then suggested and discussed that avoid this problem.