Aggregate Implications of a Credit Crunch∗

We assess the common practice of trying to learn about the sources of aggregate fluctuations using aggregate data and a representative agent framework. We take an offthe-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: it shows up as an efficiency wedge if productivity is heterogeneous, as an investment wedge if investment costs are heterogeneous, and as a labor wedge if recruitment costs are heterogeneous. Furthermore, all three model variants have an undistorted Euler equation for the aggregate of firm owners. Our conclusion is that, while trying to learn about the sources of business cycles using a representative agent framework and aggregate data alone may seem appealing, this approach is invalidated by the presence of heterogeneity. We thank Manuel Amador, Marios Angeletos, Roland Bénabou, Markus Brunnermeier, Mike Golosov, Urban Jermann, Patrick Kehoe, Stephen Redding, Richard Rogerson, Esteban Rossi-Hansberg and seminar participants at Princeton, the Federal Reserve Board of Governors, Rutgers, Minneapolis Fed, Wharton, Georgetown, NYU, Boston University, MIT, Ohio State, ASU, Université de Montréal and 2011 NBER Summer Institute and Minnesota Workshop in Macroeconomic Theory for useful comments. UCLA and NBER, [email protected]. Princeton University, [email protected].