How Low Interest Rates Discern the Bubbles Nature: Leveraged vs Unleveraged Bubble

Leveraged asset price bubbles, i.e., periods of boom-bust phases in asset prices accompanied by credit overhangs, are more harmful than unleveraged ones, in terms of financial and price stability. As bubbles are difficult to detect in real-time data, early researches focused on the macroeconomic conditions exacerbating the bubbles' nature. What kind of bubble is likely to emerge in an economy characterized by slow growth and a low real interest rate? This paper shows why the leveraged bubble is the answer to this question. First, we show that a negative real rate is sufficient for leveraged bubbles to emerge but not for unleveraged ones, in a stylized OLG model with incomplete credit markets and income inequality. Second, we show that this result holds empirically for post-World War II bubbles in advanced economies.