Abstract: We take an off-the-shelf model with financial frictions and heterogeneity,
and study the mapping from a credit crunch, modeled as a
shock to collateral constraints, to simple aggregate wedges. We study
three variants of this model that only differ in the form of underlying
heterogeneity. We find that in all three model variants a credit
crunch shows up as a different wedge: efficiency, investment, and
labor wedges. Furthermore, all three model variants have an undistorted
Euler equation for the aggregate of firm owners. These results
highlight the limitations of using representative agent models to
identify sources of business cycle fluctuations.

Full article can be found here.