In an especially uncertain environment, lenders may become so cautious that credit supplies are cut back more than would be justified by an objective assessment of borrowers’ prospects; concerns about counterparty risk can impair the smooth functioning of payment and settlement systems, interfering with a wide variety of markets; asset prices can be driven well away from equilibrium values; and confidence can be undermined.
These types of tail events could depress economic activity for a time and, if prolonged, could also adversely affect efficiency and productivity by impairing the ability of financial markets to channel savings into the most productive investments.