Stabilizing an Unstable Complex Economy

This paper analyzes a range of alternative specifications of the interest rate policy rule within a macroeconomic, stock-flow consistent, agent-based model. In this model, firms' leverage strategies evolve under the selection pressure of market competition. The resulting process of collective adaptation generates endogenous booms and busts along credit cycles. As feedback loops on aggregate demand affect the goods and the labor markets, the real and the financial sides of the economy are closely interconnected. The baseline scenario is able to qualitatively reproduce a wide range of stylized facts, and to match quantitative orders of magnitude of the main economic indicators. We find that, despite the implementation of credit and balance sheet related prudential policies, the emerging dynamics feature strong instability. Targeting movements in the net worth of firms help dampen the credit cycles, and simultaneously reduce financial and macroeconomic volatility, but does not eliminate the occurrence of financial crises along with high costs in terms of unemployment.