The purpose of our work is to explore contagious financial crises. To this end, we use simplified, thus numerically solvable, versions of our general model [Goodhart, Sunirand and Tsomocos (2003)]. The model incorporates heterogeneous agents, banks and endogenous default, thus allowing various feedback and contagion channels to operate in equilibrium.
Such a model leads to different results from those obtained when using a standard rep- resentative agent model. For example, there may be a trade-off between efficiency and financial stability, not only for regulatory policies, but also for monetary policy. More- over, agents which have more investment opportunities can deal with negative shocks more effectively by transferring ‘negative externalities’ onto others.
