Question

At a broader level, some economists worry about a leverage cycle, where "leverage" is a term used by financial economists to mean "borrowing." When economic times are good, banks and the financial sector are eager to lend, and people and firms are eager to borrow. Remember that the amount of money and credit in an economy is determined by a money multiplier—a process of loans being made, money being deposited, and more loans being made. In good economic times, this surge of lending exaggerates the episode of economic growth. It can even be part of what lead prices of certain assets—like stock prices or housing prices—to rise at unsustainably high annual rates. At some point, when economic times turn bad, banks and the financial sector become much less willing to lend, and credit becomes expensive or unavailable to many potential borrowers. The sharp reduction in credit, perhaps combined with the deflating prices of a dot-com stock price bubble or a housing bubble, makes the economic downturn worse than it would otherwise be.

(True/False)

Answer 1

A leverage cycle refers to the fluctuation in lending during various economic conditions, which can exaggerate growth during good times due to the money multiplier effect, and deepen recessions during bad times when banks restrict lending and credit becomes scarce.

Step-by-step explanation:

The concept of a leverage cycle is key to understanding fluctuations in the economy, particularly related to how banks and financial institutions react to changes in economic conditions. When economic times are good, there is a high tendency for banks to lend more freely and for firms and individuals to borrow more, enhanced by the money multiplier effect, which can exaggerate economic growth and lead to the inflation of asset prices such as stocks and housing. Conversely, during economic downturns, banks become reluctant to lend, which makes credit less accessible, thereby exacerbating the downturn, as seen in events like the dot-com bubble and the 2007-2008 financial crisis.

The process by which banks make loans is crucial for the creation of money within financial capital markets, however, when these banks face financial stress with a widespread decline in their asset's value, it results in a contraction of