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This paper greatly benefited from extensive comments by Daniel Hardy and Kenneth Sullivan.
Notice also that the income coefficient of external borrowing is close to zero (i.e., foreign borrowing by central banks is independent of the countries’ income level). Borrowing abroad seems to be the first thing central banks do.
This is measured as the average standard deviation over the period 1993–2003 of all the main items of central banks’ balance sheets, defined in the same way as that described above (i.e., claims and liabilities on the external, public and private sectors).
The data is drawn from the IMF AREAER database.
We check whether the country has experienced a financial crisis during the period 1993 to 2003. The data comes from Luc Leaven and Fabien Valencia (2008).
The KKM index, developed by Daniel Kaufmann, Aart Kraay and Massimo Mastruzzi, measures six dimensions of governance including voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. It ranges in units ranging from about -2.5 to 2.5, with higher values corresponding to better governance outcomes.
The data comes from the OECD’s country risk classification.
The sum of the sub-sample averages does not exactly sum up to zero because of differences in sample sizes.
To avoid introducing a possible scaling bias, the regressions of profits versus balance sheet items are done in full natural values, rather than ratios to GDP. This however tends to raise the regressions’ R-squares somewhat artificially (differences in GDP levels show up on both sides of the regressions).
While it could well be socially optimal for a central bank to raise its operational expenditures to the point where it brings its profits to zero (this could be necessary to improve the quality of its monetary or prudential management), this should produce a negative correlation between profits and operating expenses, not a positive correlation.
Notice that profits in this paper are defined prior to any dividend transfer to the shareholder. Hence, weak profitability can only arise from the structure of the balance sheet and the interest rates paid on the various assets and liabilities. A further weakening of central banks’ financial conditions could result from unwarranted profit distributions (for example, compulsory minimum distributions even when there are no profits, which amount to programmed decapitalizations).