Leverage–led growth in the circuit of capital model with a banking sector

Economic growth in the circuit of capital model with effective demand is fundamentally leverage-led. This paper extends the circuit of capital model by incorporating a banking sector and related financial variables, identifying three types of growth regime: firm leverage-led, bank leverage-led, and investment-led. The key findings are as follows. First, growth potential is strongest when driven by investment and firm leverage, but this leads to an unbounded rise in the interest rates. In contrast, bank leverage-led growth imposes upper limits on both growth and the interest rate. Second, the interest rate rises across all growth types, except in bank leverage-led growth, where the interest rate may fall under certain conditions. Third, the effects on financial fragility differ across growth types: investment-led growth has no impact on it, firm leverage-led growth raises it, and bank leverage-led growth reduces it. • Firm leverage drives stronger growth potential than bank leverage. • Firm leverage-led growth increases both interest rates and financial fragility. • Bank leverage-led growth weakens financial fragility and may lower interest rates. • Investment-led growth mirrors firm leverage-led but won’t alter financial fragility.