From Interaction to Business Fluctuations: How Credit Network Explains Cycles

Abstract We investigate the dynamic properties of capital flows in the U.S. economy by developing and estimating a heterogeneous agents macro‐economic model in which credit, deposits, and interbank relations evolve endogenously through optimal decentralized choices under limited information. Our findings suggest that severe financial crises stem from the endogenous formation of a highly centralized financial sector. In this setting, a self‐reinforcing bank run against systemic intermediaries, although rare, can freeze the interbank market, disrupt a large share of credit lines, and trigger a deep recession. These results underscore the need for prompt policy intervention to prevent cascading effects and costly bailouts.