From interaction to business fluctuations: How credit network explains cycles

In this paper, we investigate the dynamic properties of capital flows in the US economy by developing and estimating a microfounded heterogeneous agents macroeconomic model describing the endogenous formation and evolution of credit, deposits, and interbank relations. Indeed, we aim to assess the characteristics of the financial network underlying the observed fluctuations at the aggregate level and evaluate the role of centralization in the outbreak of largescale crises. Our findings indicate that the emergence of severe crises closely relates to the endogenous formation of a highly centralized financial sector. In particular, we show that investors and banks prefer large financial institutions to allocate their capital or borrow additional liquidity. Accordingly, a bank run hitting those systemic intermediaries, even if extremely rare, has a non-negligible impact on the economy since a considerable share of financial trans- actions and credit lines depends on their correct functioning. Moreover, since economic agents prefer large financial institutions, a sudden withdrawal of resources, by reducing their attractiveness, tends to be self-reinforcing, thus exacerbating the crisis. Overall, that indicates the need for the policymaker to intervene promptly during those events and avoid vicious circles and more costly bailouts.