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Policy in Adaptive Financial Markets—The Use of Systemic Risk Early Warning Tools

How can a systemic risk early warning system (EWS) facilitate the financial stability work of policymakers? In the context of evolving financial market dynamics and limitations of microprudential policy, this study examines new directions for financial macroprudential policy. A flexible macroprudential approach is anchored in strategic capacities of systemic risk EWSs. Tactically, macroprudential applications are founded on information about the level, structure, and institutional drivers of systemic financial stress and aim to manage the financial system risk and imbalances in two dimensions: across time and institutions. Time-related EWS policy applications are analyzed in pursuit of prevention and mitigation. EWS applications across institutions are considered via common exposures and interconnectedness. Care must be taken in the calibration of macroprudential applications, given their reliance on quality of the underlying systemic risk-modeling framework.

JEL classification: G01; G18; G28; E32; E37.

Keywords: financial stability, regulation, macroprudential, policy instrument, early warning system, systemic risk, financial stress, imbalance.

Suggested citation: Oet, Mikhail V., Stephen J. Ong, and Dieter Gramlich, 2013. “Policy in Adaptive Financial Markets—The Use of Systemic Risk Early Warning Tools,” Federal Reserve Bank of Cleveland, Working Paper no. 13-09.

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