Macroeconomic stress testing is a risk management technique employed by financial market regulators to evaluate how an institution’s financial condition could be affected by specified changes in risk factors under severe yet plausible economic scenarios. It plays an essential role in financial market risk management and supervision. This paper extends the technique to the household sector by developing a micro-founded simulation framework constrained by macro-consistency to assess household financial security. I apply this framework to Canadian households using the 2023 Macroeconomic Stress Testing (MST) scenario developed by the Office of the Superintendent of Financial Institutions (OSFI). The resulting stress test outcomes are consistent with statements regarding Canadian households in the Bank of Canada’s 2023 Financial System Review. Crucially, I find that accounting for income distribution significantly amplifies stress test results, revealing a pronounced middle-class squeeze effect.
Patrick X. Li (Fri,) studied this question.