These observations lead to the important question of whether and how financial vulnerabilities should affect the setting of monetary policy. One simple framework for evaluating the tradeoffs associated with actively setting monetary policy to lean against the buildup of financial vulnerabilities is to examine the costs and benefits of such a policy in terms of unemployment and inflation.
In this approach, the costs of tightening monetary policy in response to a buildup of financial vulnerabilities are lower employment and potentially below target inflation in the near term. The benefits are possibly reducing the risk of a future financial crisis, an event likely associated with a much larger fall in employment and inflation.