Stock-Flow Consistent Modeling of Default Events Sequence in a Closed Economy

Abstract

By sequentially examining the full chain of events starting from the default of firms through the fire-sale of goods towards the write-offs of bad loans, we develop a new matrix of financial transactions. This matrix is incorporated into the transactions-flows matrix of the closed economy consisting of households, firms, and banks. On the basis of the balance sheet and transactionsflows matrices, this study further constructs a stock-flow consistent model of the closed economy. We also provide the results of a numerical simulation and argue that our model allows studying how such key parameters as the probability of default, the rate of fire-sales (new injected parameter), the recovery rate, and interest rates on loans and deposits affect the performance of banks and firms, observing economic dynamics in time.