Heterogeneity and redistribution in financial crises

This paper uses a simple heterogeneous-agent economy model to show that redistribution of wealth among heterogeneous agents can play a significant role in business cycle dynamics and financial crises. In an economy where firms with heterogeneous productivity operate under borrowing constraints, redistribution of wealth reproduces the key features of business cycle fluctuations such as persistence and nonlinearity in output and labor, and procyclicality in observed productivity. This model suggests the hypothesis that a redistribution shock may be one of the key driving forces of business cycles. The aggregate variables exhibit strong nonlinearity in both our model and the standard model: however, while the behavior of individual agents does not involve nonlinearity in our model, strong nonlinearity is assumed in the standard model.