Looking great. Should be fun when things are all up and running. I like your idea of filling the bar windows with a photo of the inside of the bar. Should work a treat.
As far as how to take care of the outskirts and suggesting the rest of the village beyond the square...
Photos would work. I can't see any reason why not. Its a trick I've used when doing 3D computer animated scenes. Surround the set with a cylindrical wall with panaramic photos projected on the inside.
Perspective matt painting would also work, a trick from old school film set dressing. Depends on how handy you feel with a paint brush.
Another possible approach related to matt painting, allows for building more and painting less, but might depend a bit more on the available room. Build the rest of your village essentially flat, several layers of card. Make use of forced and diminishing perspective, less detail and depth the further away. These can then be arranged into the background area, sort of pop-up book style if you will. This method would let you 'construct' the village if you don't feel comfortable with drawing or painting it.
Not sure if I've made a whole lot of sense there. Oh well.
Can't say I've tried any of the above ideas on a diarama, but I have done them all at one time or another. The pop-up style version I used on puppet theatre sets that I helped a friend build when I was still hopefull of being able to survive as an art glassblower.
No doubt there is one way that will strike as being more suited to your situation (and personality) than others.
Whatever you do, I know it'll look great.