Central Bank Financial Strength and Macroeconomic Outcomes

Abstract:     
Central bank financial strength has not been a significant issue for a substantial period of time. However, recent theoretical and empirical literature argues that even central banks require sufficient level of financial strength to perform functions effectively and achieve their objectives. In this study, we examine the relationship between central bank financial strength and selected macroeconomic outcomes using an unbalanced panel dataset for selected advanced and emerging countries. We empirically model macroeconomic outcomes represented by price stability, output growth, real interest rate variability and nominal exchange rate variability with the measures of central bank financial strength. We observe that price stability is broadly related to central bank financial strength and find evidence to suggest that real interest rate variability can also be explained to a certain extent using central bank finances. Hence, empirical evidence suggests that weak central bank finances negatively impact the ability of policy makers to react inflationary pressures and interest rate instability. Our results have important implications for policy makers and central bankers. Particularly we suggest that maintaining health of central bank balance sheets and avoiding undue and persistent losses remain vital pre-conditions for desirable policy outcomes.

Number of Pages in PDF File: 61

Keywords: Central Bank Capital, Net Worth, Financial Strength, Macroeconomic Outcomes

JEL Classification: E42, E52, E58, E63

working papers series