‘Positive’ 25 years for Central Bank despite failing to spot crash, says Honohan

In weighing up the Central Bank’s recent history, it’s hard to see past its failure to reign in reckless lending by banks in the lead up to the crash or to warn about the evident overheating of the Irish economy before it was too late.

However, even with these significant regulatory shortcomings, former governor Patrick Honohan believes the last 25 years have been its most successful.

In an economic letter, evaluating the performance of the Central Bank since its inception in 1943 to the present day, Prof Honohan said the recent period, with the exception of the crash, had seen a strong improvement in the State's main economic indicators.

Since 1993 inflation had averaged less than 2 per cent while employment growth had averaged 2.5 per cent, he said, which contrasted with the previous period which was characterised by frequent bouts of hyperinflation and economic instability.

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In his letter, Prof Honohan, who is credited with overhauling the Central Bank’s culture in the wake of the crash, noted the Irish Free State allowed two decades pass before creating a central bank, relying instead on a currency board arrangement, pegging the Irish punt to sterling.

Three periods

Breaking the bank’s 75-year history into three distinct periods, Prof Honohan described the initial 25-year phase from 1943 to 1968, when Irish banking continued to be a satellite of the British system, as a period of “postcolonial quiescence” where the bank exercised few of its powers but frequently criticised the government over its expenditure plans.

“The funny thing about the early years of the Central Bank is that it used almost none of the powers that it had been given, operating largely as if it was still a postcolonial currency board, managed by the same team,” he said.

Prof Honohan noted that during this period 90 per cent of the Central Bank's foreign exchange reserves were held in sterling; the commercial banks continued to use the London money market for liquidity; the commercial Bank of Ireland, established by royal charter in 1783, continued to be the Irish Government's main banker.

Monetary instability

The subsequent period from 1968 to 1993 was defined by monetary instability, characterised by double-digit inflation imported from Britain and from the oil shocks, and repeated currency devaluations against sterling “needed to protect the Irish economy at a time of soaring fiscal deficits”.

Under the heading “coping with hyperglobalisation”, Prof Honohan suggested the last 25 years, apart from the 2008-2011 crisis, has been a period of, on average, strong improvement in the main macroeconomic aggregates.

He noted that globalisation has been accompanied by less of a deterioration in Ireland than in other advanced countries.

Looking to future

As to what the future holds for the bank, Prof Honohan suggestsed the power of the big deposit banks is likely to be eroded further by resolution policies, which ensure they are no longer too big to fail; technological innovations; and if there is a failure to establish a culture of service to their retail customers.

Despite the highly complex nature of the global financial system today, Prof Honohan said the core function of the Central Bank, however, “ will remain the same, preventing the abuse, public or private, of monetary systems that can destabilise economies and damage the economic welfare of their inhabitants”.