What is a caricature? The dictionary defines it as "a picture, description, etc., ludicrously exaggerating the peculiarities or defects of persons or things". When most of us here the word "caricature", we think of something like this:
As a literary device, caricature is described as "a device used in descriptive writing and visual arts where particular aspects of a subject are exaggerated to create a silly or comic effect".
Here's a very recognizable example of caricature: in the Fox animated sitcom Family Guy, a character is introduced as a part of a domestic violence plot in Screams of Silence: The Story of Brenda Q (Season 10, Episode 3). The character—Jeff—is the loud, obnoxious, abusive boyfriend of Brenda Quagmire.
The episode is intended to deal with the serious subject of domestic violence, but given typical Family Guy style, the subject is pushed to such an extreme that the character of the abuser is too much of a joke to take seriously. Every second the character is onscreen, he is behaving in the most radical manner possible to remind viewers he is an abuser. Family Guy, as usual, relies on serious stereotype (which is another way of using caricature) to push the point even further (he demands money so he can buy cigarettes and wallet chains; the viewers must understand he is white trash, after all).
Family Guy may be excused because it is, after all, satire. Caricature is a valid literary device, and satire is where it is best used. When writing non-satirical works, however, pushing the extremes to an ultimately black-or-white conclusion usually leads to unintentional caricature, and this can weaken your story.
When it comes to character development, it can be very tempting to define your characters by extreme stereotypical traits. Your "white knights" might be stereotypically virtuous in all that they do, in every situation. Your villains may be driven to the most wicked, reprehensible acts imaginable, even some which may be out of proportion for the situation, setting, or character.
JK Rowling is one of my favorite authors, but I could happily skip every section in the Harry Potter series involving the Dursley family. Yes, there are reasons the family gets represented in extreme fashion, but for me they constantly come off as cartoon characters. This distracts from the tone of the story, though. Quite often it pushes the limits of my belief as a reader, and this frustrates the reading experience. Thankfully in Potter, the exposure to the family is limited and the caricature doesn't follow through into the more important parts of the books (except where used for comic effect, as intended).
It is an easy, but unskilled, mistake to make to believe you must convey your character through severe examples of ultimate good, or evil, or perhaps some other trait. Your typical "horny" character may never have a line that isn't sexual innuendo; you may want to write an "airheaded" character whose every action is a vapid response. Usually, when authors do this, they also simply tell the reader that this is the character's most noticeable trait. Main characters may define them this way ("Ronnie was an insatiable horndog, all the time"; "Typical Ronnie and his sex-obsessed brain"; "Why couldn't Ronne ever think of anything but sex?").
Remember that real people aren't like this. You may have an acquaintance or two you may think is a living caricature, but usually, they are not. Resorting to these kinds of stereotypes creates two-dimensional characters, and once they've conveyed their out-of-proportion antics in one or two on-screen moments, they become useless to the story. Unless you are aiming to create a Family Guy-style, over-the-top, highly unlikable character, this is a poor use of your craft.
The facets of character are better conveyed in subtlety and layers. There are almost no pure black-and-white extremes. Even Michael Carpenter, the "paladin" of The Dresden Files, may appear to be perfectly righteous and without doubts...but he is not, and Jim Butcher shows this to us as well.
Consider this: who will identify with your characters if your characters are beyond the scope of compassionate characteristics? Who are the heroes we most love? The ones who are not perfect, who have doubts, who have at least a little vice, who can appreciate the faults in others without merely pitying or ministering to them. Who are the villains we most love? Those who have backgrounds we can sympathize with and traits we can identify with, despite their evil choices.
A good way of preventing two-dimensional characters is to make yourself understand them as people, not props. You may want to write your own story about domestic abuse and in doing so you may want to create an abuser who is completely unlikable. I've certainly done it, with the character of Sölva in Lotus Petals. Even villains, however, exist in more dimensions than that of their evil side. Try to get into their head a little. Think about what their opinions and reactions are to situations which don't involve their victim or the immediate situation of their plot. How do they react to something neutral and impersonal? What will they say if you ask them their opinion on politics? How does the weather make them feel? What is their favorite food? What experiences do they appreciate?
This doesn't mean you need to give your villains a palpable "good" quality. It means you need to realize that even villains aren't thinking about villainy 100% of the time. It would seem ridiculous if you asked a villain how he liked the steak he just ate and he responded by bringing up the girlfriend he likes to punch, wouldn't it?
Let's get away from the villain example, though, and look at a more neutral character. Let's go back to that "horndog" friend I mentioned. Consider how ridiculous it would be if you asked him what sort of weather he enjoyed and he replied with a filthy remark about your sister.
But Brantwijn, you say, those characters exist! Look at the Todd, from Scrubs!
Just remember, darlings: the Todd is a joke. If you're not writing satire, you probably don't want your characters to be seen as jokes.
(And heck, even the Todd has qualities beyond being a total horndog. Don't forget the incessant high fives.)