Calibrating Macroprudential Policy to Forecasts of Financial Stability

Macroprudential policy is a relatively new responsibility for central banks and financial regulatory agencies, requiring new methods for analyzing previously untested policy tools like the countercyclical capital buffer. One of the first steps in this direction was the development of financial stability indicators (FSIs). While many FSIs have been proposed, they typically require further transformation for use by policymakers. We propose that a particular transformation based on transition probabilities between states of high and low financial stability be used, and demonstrate how to use these probabilities within a decision-theoretic framework to guide the implementation of U.S. countercyclical capital buffer policy.