Periods of excessive leverage, rapid credit growth, or buoyant credit market sentiment increase the risk to economic growth.3 These dynamics point to the possibility that accommodative monetary policy, while necessary to support activity during the early stages of an economic expansion, may also increase vulnerabilities in the financial system, especially if maintained for too long.
These vulnerabilities weaken the financial system’s ability to absorb negative shocks, and so when a shock arrives, losses mount, the financial system weakens, lending slows, and economic activity slows by more than it would have otherwise, potentially leading to an economic downturn or a more severe recession. Should Financial Vulnerabilities Affect the Stance of Monetary Policy?