Economic model shows how foreign credit creates fake growth booms that crash — and how to stop them

A new economic model explains why emerging markets that suddenly open themselves to foreign borrowing experience sharp growth spikes followed by long stagnation. The mechanism is simple: cheap foreign money pushes up asset prices, which makes borrowing easier, which fuels investment that seems to confirm the initial optimism — until it doesn't, and the whole thing collapses.

For decades, economists have been puzzled by a pattern: countries that liberalize capital markets and attract foreign credit see dramatic booms that inevitably bust, followed by years of below-trend growth. This model reveals the underlying trap — it's not just bad luck or bad management, it's a self-reinforcing cycle built into how credit works when supply is essentially unlimited. The finding suggests that countries can break the cycle by either restricting credit inflows in favor of direct investment, or by using macroprudential tools (interest rate hikes, tighter reserve requirements) to dampen the feedback loop before the boom becomes unsustainable.