The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.
- BLS Handbook of Methods
- Bureau of Economic Analysis
- Bureau of Labor Statistics
- Congressional Budget Office
- Economic Data - FRED® II, St. Louis Fed
- Office of Management and Budget
- Statistics: Releases and Historical Data, Board of Governors
- U.S. Census Bureau Economic Programs
- White House Economic Statistics Briefing Room
November 06, 2009
What is systemic risk, anyway?
On October 30, the Center for Financial Innovation and Stability at the Federal Reserve Bank of Atlanta held a conference on Regulating Systemic Risk. The presentations mostly focused on the recent financial crisis and possible regulatory responses to those developments.
Oddly enough, the term systemic risk hardly came up even though it was a major part of the conference's title. Then again, maybe it wasn't so odd.
Systemic risk is a relatively new term that has its origin in policy discussions, not the professional economics and finance literature. A search of EconLit turned up the following: The first appearance of the term systemic risk in the title of a paper in professional economics and finance literature was in 1994. That appearance was in a review of a book written by a World Bank economist, not a journal article by an economist at a university.
Given its origin in policy discussions, perhaps it is not so surprising that the term "systemic risk" often is used with no apparent precise definition in mind. If it arose from a theoretical analysis as did a term it sometimes is confused with—systematic risk— there would be a very precise definition.1
The G10 Report on Consolidation in the Financial Sector (2001) suggested a working definition:
"Systemic financial risk is the risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainly [sic] about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effects on the real economy."
While this is a reasonable definition in terms of the concerns in mind, the precise definitions and measurement of terms such as "confidence," "uncertainty," and "quite probably" are likely to be elusive for some time, if not forever. Furthermore, the definitions probably include a lot more than what usually seems to be meant by systemic risk. For example, the risks of an earthquake, a large oil price increase, and a coup fit in this definition. Or maybe "systemic risk" should include such events?
Even George G. Kaufman and Kenneth E. Scott (2003) define "systemic risk" in imprecise terms:
"Systemic risk refers to the risk or probability of breakdowns in an entire system, as opposed to breakdowns in individual parts or components, and is evidenced by comovements (correlation) among most or all the parts."
To me, this definition is better than the G-10 definition because it does not confuse the event being analyzed (the breakdown) with the cause (the loss of confidence). Even so, a precise definition of "breakdown" may be elusive even if the term is evocative.
Darryll Hendricks (2009), who is a practitioner, suggests a more theoretical definition from the sciences in which the term originated:
"A systemic risk is the risk of a phase transition from one equilibrium to another, much less optimal equilibrium, characterized by multiple self-reinforcing feedback mechanisms making it difficult to reverse."
This definition includes many words that aren't used in everyday English and is quite abstract, focusing on the mathematics to characterize the situation. That said, this definition has a better shot at being more precise in terms of economic and financial analysis of actual situations than does the G10's definition. But the economic content of this definition as it stands is zero.
One solution is the following: Kaufman and Scott's definition is a reasonably clear, tentative definition of the term that doesn't use too many other words that require definition. Hendricks's more theoretical definition or something like it probably is a helpful start to ways of thinking about systemic risk in analytical terms.
Group of Ten. 2001. "The G10 Report on Consolidation in the Financial Sector."
Hendricks, Darryll. 2009. "Defining Systemic Risk." The Pew Financial Reform Project.
Kaufman, George G., and Kenneth E. Scott. 2003. "What is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?" Independent Review 7 (Winter), pp. 371-91.
1In the context of the capital asset pricing model, systematic risk is the risk associated with changes in the overall stock market. It can be defined similarly in other theories of asset returns.
TrackBack URL for this entry:
Listed below are links to blogs that reference What is systemic risk, anyway?:
- What’s Moving the Market’s Views on the Path of Short-Term Rates?
- Lockhart Casts a Line into the Murky Waters of Uncertainty
- How Will Employers Respond to New Overtime Regulations?
- How Good Is The Employment Trend? Decide for Yourself
- Is the Labor Market Tossing a Fair Coin?
- When It Rains, It Pours
- Pay As You Go: Yes or No?
- Was May's Drop in Labor Force Participation All Bad News?
- Wage Growth for Job Stayers and Switchers Added to the Atlanta Fed's Wage Growth Tracker
- Experts Debate Policy Options for China's Transition
- July 2016
- June 2016
- May 2016
- April 2016
- March 2016
- February 2016
- January 2016
- November 2015
- October 2015
- September 2015
- Business Cycles
- Business Inflation Expectations
- Capital and Investment
- Capital Markets
- Data Releases
- Economic conditions
- Economic Growth and Development
- Exchange Rates and the Dollar
- Fed Funds Futures
- Federal Debt and Deficits
- Federal Reserve and Monetary Policy
- Financial System
- Fiscal Policy
- Health Care
- Inflation Expectations
- Interest Rates
- Labor Markets
- Latin America/South America
- Monetary Policy
- Money Markets
- Real Estate
- Saving, Capital, and Investment
- Small Business
- Social Security
- This, That, and the Other
- Trade Deficit
- Wage Growth