Posted

September 22, 2010 08:59:08 AM

Date

2005-04

Author

Esa Jokivuolle, Juha Kilponen, and Tero Kuusi

Affiliation

Bank of Finland, Monetary Policy and Research Department

Title

GDP at risk in a DSGE model: an application to banking sector stress testing

Summary /
Abstract

We suggest a complementary tool for financial stability analysis based on stochastic simulation of a dynamic stochastic general equilibrium model (DSGE)of the macro economy. The paper relates to financial stability research in which financial aggregates crucial to financial stability are modelled as functions of macroeconomic variables. In these models, stress tests for eg banking sector loan losses can be generated by considering adverse scenarios of macro variables. A DSGE model provides a systematic way of generating coherent macro scenarios which can be given a rigorous economic interpretation. The approach is illustrated using a DSGE model of the Finnish economy and a simple model of Finnish banking sector loan losses.

Keywords

DSGE models, financial stability, loan losses, stress testing

URL

http://www.bof.fi/NR/rdonlyres/79A1CBAE-93FE-4C59-876B-680A310C6928/0/0726netti.pdf

Remarks

This empirical paper by the staff of the Finnish central bank is practical and does not involve new conceptual insights compared to the existing literature on macro stress testing. It is useful to complement current macro stress testing methods by making use of modern macroeconomic equilibrium (DSGE) models. For a central bank using a DSGE model in its economic analysis and forecasting, it is natural to utilise it also in financial stability analysis, thereby bringing the two key central bank functions (monetary policy and banking supervision) closer together.

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