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Economic Quarterly

Fall 2007

Non-Stationarity and Instability in Small Open Economy Models

Thomas A. Lubik

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.

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