A surreal cityscape with inflated buildings representing asset bubbles.

Decoding Economic Bubbles: How Leverage and Growth Shape Asset Prices

Elliot Brynn in Business & Economy May 2025 • 3 min read.

"A fresh look at how financial leverage and unbalanced growth can lead to asset price bubbles, and what it means for the economy."

Asset price bubbles occur when the price of an asset far exceeds its fundamental value. History is filled with such events, many leading to significant financial crises and economic hardship, highlighting the importance of understanding how and why these bubbles form.

Traditional economic thinking often assumes that asset prices accurately reflect their real value, or that bubbles are rare and fragile. However, new research challenges this view, suggesting that bubbles may be more common and deeply rooted in economic structures than previously believed.

This article explores an innovative economic model that explains how asset price bubbles can naturally arise from the interplay between financial leverage and unbalanced economic growth. By understanding these dynamics, we can gain new insights into predicting and managing potential financial instability.

The Leverage-Growth Connection: How Bubbles Emerge

A surreal cityscape with inflated buildings representing asset bubbles.

This economic model focuses on the relationship between capital investment and land prices. It suggests that as financial leverage increases past a certain threshold, it can trigger a shift from stable, balanced growth to unstable, unbalanced growth, characterized by rising land prices and the formation of asset bubbles.

In this scenario, land prices increase faster than the actual rents or income that the land generates. This creates a gap between the real value and the market price, leading to an asset bubble.

Financial Leverage: Increased borrowing allows for greater investment, driving up asset prices.
Unbalanced Growth: Land prices rise more rapidly than other economic factors, creating a bubble.
Investor Behavior: Expectations of future price increases drive further investment, fueling the bubble.

According to the model, both financial loosening and technological advancements can promote this type of unbalanced growth, resulting in low interest rates, overvalued assets, and wealth concentrating at the top.

Implications and Future Directions

This new perspective provides macro-finance with a tool for understanding non-stationary asset price bubbles and offers valuable insights for policymakers and investors alike, as it emphasizes the importance of monitoring financial leverage and promoting balanced economic growth to prevent harmful asset bubbles from forming and potentially destabilizing the economy.

Everything You Need To Know

What exactly is an asset price bubble?

An asset price bubble happens when an asset's price goes way beyond its true value. This can happen for various reasons, often leading to serious financial problems and economic downturns. This situation is especially important to understand because it shows how the prices of things can become detached from their actual worth, creating instability in the financial system.

How do financial leverage and unbalanced growth contribute to the formation of asset price bubbles?

The model emphasizes that increased financial leverage and unbalanced economic growth are key factors in creating asset price bubbles. When financial leverage increases, it encourages more investment. If this investment leads to unbalanced growth, especially in areas like land prices, where prices go up much faster than the income they generate, a bubble can form. This means that the price of an asset, like land, becomes detached from its real value.

What does unbalanced growth mean in the context of asset price bubbles?

Unbalanced growth, as described by the model, occurs when certain parts of the economy, such as land prices, grow much faster than others. The economic model suggests this unbalanced growth can be triggered by increased financial leverage and advancements. This can create a situation where asset prices, like land, become overvalued compared to their actual earnings potential. It leads to the formation of a bubble.

What factors does the model identify as key in creating asset price bubbles?

The research highlights how financial leverage, unbalanced growth, and investor behavior interact to create asset price bubbles. As financial leverage increases, it allows for more investment, which can drive up asset prices. Investor expectations of future price increases further fuel this growth, intensifying the bubble. This can result in low interest rates, overvalued assets, and wealth becoming concentrated at the top.

Why is it important to understand these asset price bubbles?

The insights from the model are crucial for both policymakers and investors. It emphasizes the importance of monitoring financial leverage and promoting balanced economic growth to prevent harmful asset bubbles. By understanding these dynamics, policymakers can implement measures to stabilize the economy, and investors can make informed decisions to manage risk and avoid potential losses associated with asset bubbles. It offers a fresh perspective on how asset prices can become disconnected from their actual value, leading to economic instability.