Business fluctuations in a credit-network economy

TL;DR

This paper models a network economy with banks and firms, showing how credit linkages can cause bankruptcy chains and how monetary policy impacts the interconnected decisions of banks and firms.

Contribution

It introduces a model of a credit-network economy highlighting the role of credit linkages in bankruptcy diffusion and the interplay between bank and firm credit decisions.

Findings

Bankruptcy can spread through the network via credit linkages.

Monetary policy initially affects bank behavior.

Interactions between banks and firms influence credit supply dynamics.

Abstract

We model a network economy with three sectors: downstream firms, upstream firms, and banks. Agents are linked by productive and credit relationships so that the behavior of one agent influences the behavior of the others through network connections. Credit interlinkages among agents are a source of bankruptcy diffusion: in fact, failure of fulfilling debt commitments would lead to bankruptcy chains. All in all, the bankruptcy in one sector can diffuse to other sectors through linkages creating a vicious cycle and bankruptcy avalanches in the network economy. Our analysis show how the choices of credit supply by both banks and firms are interrelated. While the initial impact of monetary policy is on bank behaviour, we show the interactive play between the choices made by banks, the choices made by firms in their role as providers of credit, and the choices made by firms in their role as producers.