How Uzawa preferences improve the simulation properties of the small open economy model

Abstract

This paper compares a form of preferences introduced by Uzawa with additive preferences by simulating for a small open economy the optimal consumption response to permanent and temporary shocks to the world rate of interest. In simulations of permanent changes to the rate of interest, additive preferences suffer from the apparent disadvantage of requiring the rate of time preference to be changed exogenously. They also make optimal current account balances and foreign debt levels excessively sensitive to permanent and temporary changes in the word rate of interest. The simulations show that a linear specification of Uzawa preferences can yield similar patterns to simulations using additive p..