We develop a New Keynesian model with financial frictions to explore the concept of “financial dominance” in monetary policy. Our theory is based on how the path of interest rates affects firms' ex-ante capital structure decisions and ex-post financial constraints. Ex ante, firms have a “market timing” motive to exploit differences between the cost of debt and equity, leading to increased leverage during periods of monetary easing. Ex post, when a large share of firms' assets have been encumbered to finance long-term investments through debt, rising interest rates reduce the value of firms' remaining pledgeable assets, diminishing their ability to finance new investments as well as short-term production needs. Financial dominance takes two forms: (i) responding to inflationary shocks when supply is indebted requires a higher policy rate and a starker drop in output, which makes the central bank less willing to tame inflation; (ii) when faced with negative demand shocks a priori, the central bank encounters a dilemma between easing the current demand-driven recession and tightening future constraints driven by indebted supply. Our model highlights how the effectiveness of monetary policy in managing inflation and output may be constrained by past policy decisions and their impact on firms' capital structures.