Calibrating Macroprudential Policy to Forecasts of Financial Stability

Author(s): Scott A. Brave and Jose A. Lopez

The introduction of macroprudential responsibilities at central banks and financial regulatory agencies has created a need for new measures of financial stability. While many have been proposed, they usually require further transformation for use by policymakers. We propose a transformation based on transition probabilities between states of high and low financial stability. Forecasts of these state probabilities can then be used within a decision-theoretic framework to address the implementation of a countercyclical capital buffer, a common macroprudential policy. Our policy simulations suggest that given the low probability of a period of financial instability at year-end 2015, U.S. policymakers need not have engaged this capital buffer.

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Article Citation

Brave, Scott A, and Jose A. Lopez. 2017. "Calibrating Macroprudential Policy to Forecasts of Financial Stability," Federal Reserve Bank of San Francisco Working Paper 2017-17. Available at https://doi.org/10.24148/wp2017-17