If so, a decline in unemployment below its natural rate could cause inflation to quickly rise to an undesirably high level. Rapid increases in short-term interest rates to arrest such an unwelcome development could, in turn, have adverse effects on financial markets and the broader economy. Proceeding too cautiously could also have undesirable effects on financial stability.
An environment of prolonged low short-term rates could prompt an excessive buildup in leverage or cause underwriting standards to erode as investors take on risks they cannot measure or manage appropriately in a reach for yield. 16 At this point the evidence indicates that such vulnerabilities do not pose a significant threat, but the Committee is carefully monitoring developments in this area.