Page "Economic bubble" Paragraph 21

According to the explanation, excessive monetary liquidity ( easy credit, large disposable incomes ) potentially occurs while fractional reserve banks are implementing expansionary monetary policy ( i. e. lowering of interest rates and flushing the financial system with money supply ); this explanation may differ in certain details according to economic philosophy.

Those who believe the money supply is controlled exogenously by a central bank may attribute an ' expansionary monetary policy ' to said bank and ( should one exist ) a governing body or institution ; others who believe that the money supply is created endogenously by the banking sector may attribute such a ' policy ' with the behavior of the financial sector itself, and view the state as a passive or reactive factor.

This may determine how central or relatively minor / inconsequential policies like fractional reserve banking and the central bank's efforts to raise or lower short-term interest rates are to one's view on the creation, inflation and ultimate implosion of an economic bubble.

Explanations focusing on interest rates tend to take on a common form, however: When interest rates are set excessively low, ( regardless of the mechanism by which it is accomplished ) investors tend to avoid putting their capital into savings accounts.

Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as equities and real estate.

Risky leveraged behavior like speculation and Ponzi schemes can lead to an increasingly fragile economy, and may also be part of what pushes asset prices artificially upward until the bubble pops.