Rigidity and default in production networks

2026-04-26

AI Summary

This study investigates how productivity shocks propagate through production networks to generate endogenous default when information rigidity coexists with external debt. The authors develop a general equilibrium model featuring firms, banks, and consumers, integrating Walrasian rigid-equilibrium analysis with network structure to derive explicit analytical solutions. The analysis demonstrates that information rigidity invalidates leverage irrelevance and thereby undermines the validity of Hart’s theorem. While the occurrence of default is uniquely determined by real shocks and network topology, the magnitude of welfare losses further depends on economic connectedness and debt costs. The paper establishes, for the first time, the unique existence of a rigid equilibrium and uncovers the structural mechanisms underlying default contagion in interconnected economies.

Technology Category

• Game Theory and Economic Paradigms: Imperfect Information
• Multiagent Systems: Mechanism Design
• Reasoning under Uncertainty: Causality

Application Category

• Economics, Online Markets and Human Computation: Incentives in network design for Web infrastructures and ecosystems
• Social Networks and Social Media: Social media analysis through the lenses of networks
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

Abstract

This paper studies the transmission of productivity shocks in general equilibrium production networks, when firms in different sectors operate under informational rigidity and rely on external debt. Rigidity breaks the Modigliani-Miller irrelevance of leverage and may generate default following shocks, even in equilibrium. The economy consists of firms, banks, and consumers. Under proportional shock transmission, we prove that a unique Walrasian rigid equilibrium exists and provide explicit expressions for equilibrium quantities, prices, and interest rates. We show that, on the one hand, Hulten's theorem fails under rigidity, even without leverage. On the other hand, we prove that welfare is smaller than in the first best if and only if both leverage and rigidity exist. The latter increase the total cost of debt and have inflationary effects on the levered sectors, which propagate downstream, and shift consumption and labor upstream. The occurrence of default depends solely on real shocks and the network structure, while the magnitude of the losses depends also on the connectedness of the economy and the cost of debt of the connected sectors. We provide conditions for default cascades to occur and study two examples of default propagation.

Problem

• rigidity
• default
• production networks
• productivity shocks
• leverage

Innovation

• informational rigidity
• default cascades
• production networks
• leverage
• general equilibrium