This means not only that monetary policy might become less effective in achieving price stability, but also that it could have perverse effects on financial stability itself. I will consider two cases. The first case occurs when the market turmoil has been caused by excess debt accumulation by households and firms, as a result of very low interest rates over a long period.
When the bubble bursts, and agents are overburdened with a high level of debt, the interest rate tends to loose its effectiveness as an instrument to smoothen consumption and income. This is particularly the case when the assets that agents hold against their debts are not very liquid.