Addressing financial instability has become a policy priority. Despite the efforts made, policymakers are still a long way from developing a satisfactory operational framework. A major challenge complicating this task is the “fuzziness”.
The report reviews the available measurement methodologies and points out several weaknesses. In particular, it cautions against heavy reliance on the current generation of macro stress tests, arguing that they can lull policymakers into a false sense of security.
The report concludes that measurement of financial (in)stability is fundamentally “fuzzy”. This reflects a number of factors: a lack of consensus on the most appropriate analytical framework; the infrequent incidence of episodes of financial distress; and limitations in the available measurement tools. These tools are very poor at capturing the feedback effects that are at the heart of financial instability and that operate both within the financial system and between the financial system and the real economy. At their best, they can provide indications of the general build-up in risks. As a result, there is always a danger that policymakers may be lulled into a false sense of security.
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