Final answer:
Using leverage can lead to higher economic growth and increased asset values in good times, but can also result in heightened financial risk and exacerbated downturns during bad economic conditions.
Step-by-step explanation:
Using leverage means utilizing borrowed capital for an investment, expecting the profits made to be greater than the interest payable. While leverage can amplify returns during prosperous economic periods and contribute to a healthy economy, it can also increase losses and lead to a weaker economy during downturns.
On one hand, when times are good, leverage can enhance economic growth by allowing individuals and firms to invest in assets like stocks and real estate, potentially leading to high returns. This can result in asset price increases, possibly at unsustainable rates, which can build wealth and spur further economic activity.
On the other hand, in a bad economy, over-leveraged entities may struggle to service debt as asset values decline, leading to reduced credit availability. Consequently, this can have a severe impact on sectors reliant on borrowing, exacerbating economic downturns, as seen in the 2008-2009 Great Recession. Therefore, some economists propose close monitoring of asset prices and leverage cycles by central banks to moderate their effects on the economy.