Central banks ‘have never seemed so powerful,’ says Patrick Honohan

Written by Henry Goodwin on . Posted in Current events, Current features, Events, Features

When Patrick Honohan was handed the reins at the Central Bank of Ireland in September 2009, he was handed a poisoned chalice. Honohan assumed the governorship of the Central Bank at one of the most fraught moments in modern Irish history. A year on from the government’s infamous bank guarantee, and only a few months removed from the controversial nationalisation of Anglo Irish Bank, Honohan was charged with restoring confidence in Ireland’s fragile economy.

By all accounts, he succeeded. ‘He did an extraordinary job,’ said Schuman Director Brigid Laffan, as she introduced Honohan at Villa La Fonte on 27th November, the ex-governor visiting the EUI to deliver a lecture for the Florence School of Banking & Finance (FBF), supported by Fondazione CR Firenze. ‘Nearly single-handedly,’ she continued, Honohan’s tenure at the helm of the Central Bank ‘saved Ireland from political, social and economic ruin.’

Honohan is thus well-placed to reflect on the state of central banking in Europe today. Having flown into Florence to deliver a lecture asking whether the European Central Bank (ECB) and its affiliates are ‘over-mighty or under-powered’, Honohan spoke with EUI Times before taking the stage about how the financial crisis in 2008 pulled central banks, especially the ECB, into policy areas for which its mandate was not crystal-clear, forcing a more assertive approach to restoring financial stability.

‘Something happened in the 1970s and 1980s,’ Honohan explained. Responding to high inflation across Europe and the United States in the 1970s, central banks had raised interest rates, ‘forcing back demand until it matched supply, and building an expectation around low inflation.’ The result, he added, was a dawning realization amongst policymakers that governments could ‘put the whole inflation thing on autopilot and leave it to the central banks to raise or lower interest rates when needed.’ Central banking thus had something of a ‘light touch’ in the 1990s.

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Patrick Honohan believes that it was ‘obviously’ within central banks’ mandate to respond to the financial crisis.

That all changed in September 2008. ‘When central bankers woke up to crisis, they realised they needed to do something about it,’ Honohan revealed, dispelling any suggestion that there might have been panic at Europe’s central banks about what to do and whether they were allowed to do it. ‘They knew what to reach for to solve the seizing up of the financial market,’ he said, ticking off some of the ‘extraordinary measures’ put in place by the ECB – from lowering interest rates below the negative to the purchasing of government securities and the liberalisation of the collateral rules available for lending to banks.

That revealed that ‘crisis management’ was evidently part of central banks’ mandate, though it often fell behind managing inflation and maintaining price stability. ‘Central banks have been around for over 300 years,’ Honohan reasons. ‘We know what we do, and we don’t codify everything. Obviously, it’s implicit that we have to keep the money market going, otherwise we can’t do everything else we have to do.’

Yet with great power comes great responsibility and, Honohan admits, there are still many who claim that central banks on both sides of the Atlantic are acting above and beyond their station. From the outset, he acknowledges, numerous naysayers warned ‘this is going to end badly,’ that banks are going to start losing money again, or that their actions ‘are going to make it easier for governments to run up big deficits because they can borrow at lower interest rates.’

Honohan says that central bankers are not oblivious to this criticism. Instead, he contends, ‘they have to be very careful to make sure that they retain the democratic support of their actions.’ That can be difficult. The power currently wielded by central bankers, combined with the fact that they are not democratically-elected, can make them a lightning rod for criticism.

Vital to central banks’ success in taking the sting out of the Eurozone crisis was their independence from what Honohan terms ‘the pressures of the electoral cycle.’ Independence, he explains, ‘lies in having full confidence that you can continue to run the central bank even if you take steps that the government does not approve of.’ That independence is only sustainable if the banks retain the support of the general public.

The key, Honohan believes, is transparency. Central banks, especially the ECB, have an ever-increasing need to ‘very carefully communicate what they’re doing and how they’re doing it.’ That need is made more acute by the fact that central banks ‘have never seemed so powerful’ as they do today, a state of affairs which Honohan sees as somewhat bittersweet.

The ECB’s current clout is not a good thing, in so far as ‘we should never have got here.’ Nonetheless, Honohan reflects ‘since we are here, it is a good thing. It is still very much needed.’

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