Using ‘business cycle accounting’ (BCA), Chari, Kehoe and McGrattan (2006)
(CKM) conclude that models of financial frictions which create a wedge in the intertemporal
Euler equation are not promising avenues for modeling business cycle dynamics.
There are two reasons that this conclusion is not warranted. First, small changes in the
implementation of BCA overturn CKM’s conclusions. Second, one way that shocks to
the intertemporal wedge impact on the economy is by their spillover effects onto other
wedges. This potentially important mechanism for the transmission of intertemporal
wedge shocks is not identified under BCA. CKM potentially understate the importance
of these shocks by adopting the extreme position that spillover effects are zero.