A surreal cityscape with inflated buildings representing asset bubbles.

Decoding Economic Bubbles: How Leverage and Growth Shape Asset Prices

Elliot Brynn in Business & Economy December 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.

About this Article -

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2211.131,

Title: Leverage, Endogenous Unbalanced Growth, And Asset Price Bubbles

Subject: econ.th q-fin.mf

Authors: Tomohiro Hirano, Ryo Jinnai, Alexis Akira Toda

Published: 23-11-2022

Everything You Need To Know

What is an asset price bubble?

An asset price bubble occurs when the price of an asset significantly surpasses its fundamental value. This means the market price of an asset, like land, is much higher than what it should be based on its actual worth, like the income it generates. These bubbles are dangerous because when they burst, they can cause major financial crises and economic problems.

How does financial leverage contribute to the formation of asset price bubbles?

Increased financial leverage, or borrowing, allows for greater investment in assets. According to the model, when leverage surpasses a certain level, it can shift the economy from balanced growth to unbalanced growth. This unbalanced growth is characterized by rising land prices that outpace the underlying economic fundamentals. This discrepancy creates the conditions for an asset price bubble to form, because investors are willing to pay more than the asset's actual value.

What is the relationship between unbalanced growth and asset bubbles?

Unbalanced growth, as described in the model, is crucial for asset bubble formation. It occurs when certain asset prices, specifically land in this context, increase much faster than other economic factors like income or rents. This creates a disconnect between the asset's market price and its real value, leading to overvaluation. The model suggests that this unbalanced growth, fueled by financial leverage and potentially by technological advancements, is a key driver of bubble formation.

What role does investor behavior play in sustaining an asset price bubble?

Investor expectations play a significant role in fueling asset price bubbles. As land prices rise, investors often anticipate future price increases. This expectation encourages further investment, driving prices even higher. This creates a self-reinforcing cycle where rising prices attract more investment, which further inflates the bubble. The model implies that this behavior, along with financial leverage and unbalanced growth, is essential for a bubble to persist.

What insights does this economic model offer for policymakers and investors regarding asset price bubbles?

The economic model highlights the importance of monitoring financial leverage and promoting balanced economic growth. It provides a framework for understanding how bubbles can emerge from the interplay of financial leverage and unbalanced growth. For policymakers, this means closely watching the levels of borrowing and ensuring that economic growth is balanced across different sectors. For investors, this model suggests the importance of being aware of these dynamics and avoiding investments in overvalued assets, as well as the need to understand the role of increased borrowing in the economy.