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.
Lopez, Jose A., and Scott A. Brave. 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