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Closing Small and ‘Sufficiently‘ Large Open Economies with Different Asset Structures
There are two important dimensions that matter when we write down a model economy of a country that is open to international financial markets. The first one is its size, and the second one is its asset market structure. Small open economies are price takers so the analysis happens in partial equilibrium, while countries that are “sufficiently＂ large can affect international prices and the analysis happens in general equilibrium. The second important dimension is the asset market structure. If markets are complete there is full risk sharing, while if markets are incomplete there is not. In this paper I explore how these two dimensions―size and market structure―affect the conditions for the existence and the uniqueness of the equilibrium in economic models, and discuss how to achieve those conditions when they are not present. I finish by discussing how these implications change when a tax on the return to net foreign assets is introduced, generating endogenous incomplete markets.
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