Philip Lane interview: edited transcript
The Central Bank governor spoke to Arthur Beesley, economics editor of The Irish Times
Central Bank governor, Philip Lane Photograph: Eric Luke/The Irish Times
Six weeks in, what are your first impressions? You didn’t have to travel very far - it’s only a couple of hundred metres down the street from TCD.
“For now. About a year from now we’ll be moving down to North Wall Quay. So one of the 2016 projects is the completion of that building and starting the move… We’re split among multiple locations, those locations will come together in the new building… That’s going to be a big change to bring the bank together.
“My first impression: I’m reassured by the dedication and commitment of the staff I’ve been meeting so beneath the surface of the Central Bank there’s a lot going on. There’s a lot going on because the Central Bank has a very wide mandate. “Let me make two points there: After the financial crisis the policies for the financial sector and monetary policy are vastly different. So for monetary policy we have QE and other unconventional policies and for the financial sector we have new approaches to the financial ratios of banks, the single supervisory mechanism, the macro-prudential rules for mortgages, solvency II for insurance, the list goes on.
“A lot of that is essentially in cooperation with the broad European financial system of regulation. A lot of what the Central Bank does is essentially through a whole variety of European committees which is why it’s not totally visible locally because so many people are on the road, not just in Frankfurt - the ECB - we have the European Banking Authority, ESMA the European Securities and Monetary Authority, EIOPA and the then various international organisations.
“Basically the financial system is essentially international and global in scale and a lot of what is going on here has to be understood in the context of those international developments.
“Two, then domestically, Ireland has a really big financial sector beyond of course what matters most to the domestic population which is the retail banks the insurance companies they deal with the financial intermediaries they deal with, of course we’ve got this gigantic global financial sector business running out of Dublin that means there’s a high volume of supervision, regulation so there’s a lot of work here. I’ve been impressed by the range of expertise.”
In terms of your own agenda for the year ahead, what are the top three priorities within the institution itself?
“One is the appointment of a new deputy governor, that’s the most immediate. This will be concluded in this month, the month of January.
“Two is the new building programme - called Fusion - a programme of work not just to get the building built but also how to optimise it in terms of maximising its benefits for the organisation. I’ve inherited that and in many ways it’s the final stages.
“Then three, internally, in the bank there’s been an organisational review ongoing for a while. Again it’s going to crystallise in 2016. Broadly speaking it’s an example of modernisation…. fostering a one-bank culture: those involved [in] economics, interacting with those involved in banking supervision, interacting with market regulation, with those gathering statistics.
What is that designed to overcome? What’s the biggest internal weakness that the reorganisation is supposed to tackle?
“I’d be reluctant to phrase it like that. It’s more a focus on improving the organisation as opposed to saying there’s some dramatic weakness that needs to be overcome.
There’s so many common issues facing all the different parts of the bank that it makes much more sense to tackle these common issues in a collective way rather than having only those involved in economics worry about the economics issue.”
The bank has been in the news over its difficulties with pay - and the sense that it’s difficult to retain top quality people at the pay scales that prevail under the cap. ..
“The issue there is flexibility, that the bank has a mandate it needs to deliver. For example there are deadlines. Solvency II for insurance just came in on January 1 but to set that up a lot of necessary work had to be done. So you need people who have the expertise to deliver that part of the mandate.
“In banking supervision, you need to have a reasonable balance between experienced supervisors. You cannot have a situation where you have insufficient experienced supervisors. And of course with banking supervision now there’s this international alternative, with the expansion of the single supervisory mechanism there’s competition for talent between the national central banks across Europe and the SSM in Frankfurt, That will settle down over time but in the set-up of the SSM there’s pressure on national central banks.
“It’s not the case that it’s kind of across the bank that every activity the bank does face [problems]has moved quite quickly in some other dimensions so it’s not the case that it lags for years and years. Quite often it’s quite quick.”
In respect of the macroprudential rules the Minister for Finance is on record in September saying he wanted the bank to review the rules. In its public utterances, such as they were, the bank has said it’s far too early to be unwinding these rules. What’s your own personal assessment?
“The first and foremost point to make is that these rules are part of the new vision for how the European financial system should operate, it was not an arbitrary decision to introduce these rules. One of the main conclusions from the financial crisis - globally now - is that it is hard to see how you can prevent credit booms without using some type of credit control policy.
“That’s even more true inside a currency union when you don’t have a national interest rate policy. But even when you do have an independent currency you see other countries like the UK is doing it, Sweden is doing it, that there is basically a conclusion that the interest rate policy is too crude a tool to deal with credit booms. You need some versions of credit control policy.
“It’s obviously new. It’s basically setting up or implementing a widely held view of what the new framework for financial regulation should look like. So when these came in a year ago there was a huge amount of analysis and preparation behind it and there was also the consultation period and the Central Bank responded to any points that were raised.
“But the Central Bank also published quite a bit of analysis explaining why these rules came in. So the case for having rules is very robust. And again if these rules had been in place in the mid-200s, a lot of the problems would have been mitigated.
“Once these rules are in, then it is I think appropriate to analyse the impact of the rules and also to be suitably open-minded about whether these rules need to be revised from time to time.
“On the analysis, I think it’s generally agreed that the rules really only started to kick in from summer 2015 because so many mortgages in the first half of 2015 would have been preapproved. So by summer 2016 a year of data will have come in on how this has affected the allocation of mortgages Ireland.
“So the Central Bank will be receiving from the mortgage banks the details of how these rules have been implemented. So I would expect in the second half of 2016 for the Central Bank to release its analysis of what we are seeing in the market. So that’s what I think you can expect to see. And I think it’s an important responsibility of the bank - having introduced these rules - to be as rigorous as possible in interpreting the impact of these rules.
“The second point to make is that this framework is essentially structural in nature. In other words, it was not introduced in response to a short term problem in the market. It was introduced as a permanent feature, that there would be rules in place, so the fact of having rules there I would envisage to be a permanent feature in place. The fact of having rules I would envisage to be a permanent feature of the world.
“I think there are several options. One is, if you go back and read some of the analysis around the introduction of the rules that the Central Bank itself put out, it was open-minded about that over time when there’s other data available - for example once the credit register is operating well in a couple of years from now - for example the loan to income ratio rules that could be reviewed in the context of looking at a debt to income alternative because once the credit register is there there will be more information about the wider set of debts a household has.
“The rules I think could be adjusted upwards or downwards. It’s not the case that the Central Bank picked the most severe rules. Those rules can be adjusted, recalibrated, but it’s not the case that we’d expected to see [this reviewed] every quarter. It’s not like the interest rate. In other words the ECB can adjust interest rates every six weeks in principle so interest rate policy - because it’s technically not that hard to move interest rates or QE around - for these rules there’s a high value to stability and continuity. So we have these rules in place.
“What we’ve seen in the housing market since then: first of all, not everything we’ve seen should be attributed to these rules. It would be basically an analytical error to attribute everything to these rules but equally a lot of what we have seen is consistent with what the Central Bank said would happen. So the Central Bank did expect that there would be a shift towards more people renting. I think it’s not surprising that there’d be a shift from a softening of Dublin house prices to an increase in house prices in the wider commuter belt. So these are partially the effect of the rules but partially also we have a very strongly growing economy. So the pressure on the Dublin housing market is partly due to the success of the employment growth in Dublin, the softening in Dublin is partly due to the very strong price appreciation in the previous year or two. Markets don’t move in a kind of a smooth fashion. So there’s probably the reallocation between Dublin house prices and commuter belt house prices was probably partly due to an overshoot in the other direction in 2014.
“So when we have the data about how the mortgage market has been affected. I think the number one is to analyse. But I think the Central Bank has committed that if we see strong reasons to vary the rules we’re perfectly open minded about that. But these should be seen as basically a permanent feature of the system. Also, the impact of the rules. The data from 2014 is [that] banks were already imposing for their own reasons - a lot of their mortgages were with loan to value ratios not that far away from the new rules.”
Have you had pressure from the banks themselves or have the banks themselves said anything to you about the operation of the rules? At the anecdotal level, what’s the sense of it at the moment?
“I have not had any direct lobbying from the banks or from anyone else. I read the newspaper reports where plenty of people express their opinions…
“In the same way that we have no real extra information yet, the banks or any other interested party I’m sure are holding on to the views they had during that consultation period which was only a year ago.”
This will be in the second half of the year?
If a year of data has come in by the summer then it’s going to take some time to analyse, but the Central Bank will be as prompt as possible. There is a vacuum. I agree that the Central Bank needs to be prompt and transparent in sharing its analysis of the impact.
Essentially what you’re saying is - in your own words - you’re willing to vary the rules if that’s what the analysis suggests is required?
In either direction. It’s important to say that.
You’ve observed the economy is growing strongly. We’re clearly in post-crisis mode. What in your sense is the big lesson from the crisis and has that lesson been learned by the Irish people and by Irish politicians?
“I think the lesson from the crisis which applies now just as much as in the height of the boom, is that it’s important to welcome good economic developments. It’s important to celebrate increases in employment and so on but it’s also important to be very aware that the Irish economy, it’s a small economy and it’s extremely plugged into the global economic and financial system. What that means is that it can go through long periods of very good growth but it’s also vulnerable to reversals.
“It’s of course necessary to make forecasts of what you think is going to happen but it’s more important to be prepared to be wrong. Banks have to be prepared for disappointing outcomes. The Government has to be prepared for disappointing outcomes - and households, equally, in terms of their plans for how quickly their incomes are going to go up over time and so on, you might be optimistic but you probably should be organising your financial affairs recognising that reverses can happen. Hopefully future reverses will not be on the scale of what we saw in 2008 and essentially this goes back to the shared responsibility between the Central Bank and the Government to do what it can.”
“What does it mean? For the Government it means that it needs to have the kind of fiscal flexibility to deal with downturns. What does that mean? It means when times are going well that you reduce the public debt, you build up the surpluses so that when the downturn comes you can relax, you can have a fiscal injection to the help the economy to get through a crisis. That’s important but that goes hand in hand with the Central Bank pursuing a similar philosophy. So trying to mitigate volatility by the mortgage rules. We also have a new instrument - the counter cyclical capital buffer - which may also play a role. So we have some roles like that.”
“Then in terms of resilience is making sure that if there is financial distress that it doesn’t spiral into kind of the crisis situation we’ve had before. So what does that mean? It means banks hold enough capital and that banks essentially also hold enough bail-in-able debt, subordinated instruments that can take the hit before taxpayers take a hit, before depositors take a hit. That’s a European-wide and global phenomenon - make the banks more resilient, make financial distress less catastrophic. There’s a big agenda there.”
When you say about having a degree of financial flexibility, would you be among those who had concern around the Budget in October in which supplementary expenditure was increased by €1.5 billion on the Friday before the Tuesday budget against the backdrop of a situation where the Government was saying there would be no going beyond the fiscal space as set the previous March?
“The broad issue is that I was a strong supporter of the new fiscal framework for Europe but that this should be implemented in a smart way. What does that mean? It means that where it makes sense - at a European level - to have a flexible interpretation of the rules that that can be achieved. For example, with security risks in Europe, the refugee crisis in Europe, it would be self -defeating to say we can’t deal with these crises because it’s going to violate some numerical rules.
Fiscal policy is to deal with the challenges you’re confronted with?
“Right. So the fragility of the Stability and Growth Pact pre-crisis, there’s an excessive focus on a small set of numbers as opposed to having that coherent overall view of the fiscal situation.
“In the Irish context I think it’s very important to have the anchor of respecting that fiscal framework. The most important point to make there is the remarkable improvement in the Irish fiscal situation. Over the course of the crisis - with a lot of sacrifice by the Irish population, a very severe fiscal austerity - the kind of fiscal adjustment so far has been remarkable.
“So the transition now ... going into a period a decent growth and decent revenues is essentially I think the challenge for the political system is to recognise that the flipside of having the flexibility to have a fiscal stabilisation during recessions is to build up reserves during good times. Where we are now is an intermediate case because when unemployment is still nearly 9 per cent it is not the case that we are at full employment, it is not the case that we can say that the economy is overheating.
“So I’m sympathetic to the idea that we are currently in an intermediate case where a range of views can be held about where fiscal policy should be positioned. The range of views between what the Fiscal Council is saying and what the Government is doing is actually quite narrow. It should not be over-interpreted.”
Where do you stand on that range?
“Again I would take the view that the Fiscal Council has the authority now to hold the Government to account on its implementation of fiscal policy.
So you’re not saying?
“That I think is one of the good developments of the new reforms is that there’s now a coherent formal structure by which the Government is held to account by the Fiscal Council. The Central Bank will always reiterate the general principles that the Government should be prudent, should be countercyclical and should respect the fiscal framework, but the fine detail of the how the Government implements the fiscal framework, I respect the role of the Fiscal Council.”
So the Fiscal Council says the supplementary estimates were a departure from prudence. what do you say to that?
“I think that’s a natural dialogue between the Fiscal Council and the Government.”
What of the debate around the election? You can’t wake up of a morning without some story about one manifesto nugget or another. The entire debate seems to be around what the taxpayer is going to get back. There’s a lot of focus on a tax-cutting agenda on the abolition of USC and all of that. What’s your own response?
“The Fiscal Treaty, the fiscal framework, is silent on the size of government in the economy and the scale of taxes. Essentially it’s core to any democratic political system to have a debate between those who want high expenditure on public services paid for by a high level of taxation and however that taxation is raised versus those who prefer a more limited public sector lower taxes… It’s perfectly possible to have a vigorous debate about the democratically preferred size of the public sector in terms of scale of public services, scale of redistributions, scale of transfers, but of course behind that is the plan for taxes, how is each party proposing to finance that through taxation.
We’re at the outset of an election debate which will very likely concentratate on what taxpayers get back. Do you think that debate takes full account of the challenges already met but also the challenges which remain, given high debts and ireland’s exposure to the global economy?
“Politicians - through their work in government or Oireachtas committees - have no shortage of information about the challenges facing Ireland. I’m sure all politicians are very aware of the implications of an ageing population for pensions, for healthcare. Right now of course Ireland has a lot of young people. In the education system there’s obvious demographic pressures also. Those conditions: I’m sure the political parties have a high level of awareness.”
“The legacy of the debt: it’s important to say now interest rates are low, including the interest rate the Government has to pay on its debt. In the short term we can expect that to be there for a while but at some point - and this is global debate.
“Is it that these super low interest rates are going to be a medium term future for the economy? Because when you’ve a high public debt ratio the ability of the government to fund other types of spending is greatly facilitated by low interest rates but that’s not necessarily a permanent feature of the world…
“For us, on balance low interest rates are helpful….
What of the European dimension to the job? You more than any other Irish person know more about the trajectory for interest rates?
“There’s a high level of common understanding about the current situation in Europe .
“There’s no mysterious strategy.”
Re the December meeting: the press conference was still under way and markets were responding badly?
“The fact that it was less than some market traders expected did mean that there was kind of a bounce in response to the December meeting but it’s still the case relative to the mid-October meeting that there’s been a significant loosening of monetary conditions.
“I would not view the market response on that day as kind of ‘the judgment’ on the impact of the programme.”
The read through was that the ECB was saying that QE was in fact working?
“One level is to make QE more routine. There was big debate in 2014 about the expansion of QE to include sovereign purchases.
“To go from not having a sovereign purchase programme to having a sovereign purchase programme that was a big decision. And then basically one year later by December there’s an issue about recalibration saying we have this is it doing what we want it to do.
“By that point there was plenty of evidence that QE was effective, that it was helping to increase credit growth in Europe, is helping to reduce lending rates in some countries... So if you see an instrument that works, and with the evolution of data in 2015 I think the position was that more is needed for the ECB inflation target was hit but at the same time because the European economy is growing - in 2015 there was a reasonably OK growth performance at the European level - that essentially the extent of the recalibration would be of this order.
“But it’s important to say that no door has been closed. If the data flow over the next number of months is that more needs to be done, more can be done. In other words, it’s now becoming more of a normalised instrument that every number of months the analysis can be updated and that if more needs to be done, more can be done.”
Your predecessor is on record saying QE is very definitely for the good in the Irish context?
“Europe with a single monetary framework - whether it’s with QE or a single interest rate - clearly has asymmetric effects depending on conditions at a national level. So at a national level QE is going to be more important to those countries where credit conditions were tight. So for Spain, Italy, Portugal, Ireland and so on QE is going to be more important than for Germany, where essentially the credit mechanism was in better shape.
“At the governing council level, these decisions are made for the collective. It’s not done as a redistribution exercise, treating Europe as a collective system. Maybe this goes back to the interaction between monetary policy and macroprudential policy. The recipe has to be that you only have one interest rate policy and you can only have one central bank QE policy so, if there are kind of national asymmetries around that, an important way to deal with that is by having additional tools, including macroprudential tools at national level. There’s the mortgage rules, there’s the countercyclical capital buffer, those kind of strategies.
What do you make of the Fed’s decision and what does it mean?
“I think this is important to say is that the financial system is ultimately global in nature. We saw that in the boom where essentially development s in the US had a big impact in Europe and other parts of the world. And it remains true today that the role of the dollar in the global financial system is much higher than the role of the US in global GDP. The impact of the funding conditions in the dollar market has global consequences. Less so for Europe though than for many other countries because of the fact that the euro area is a large economy that essentially corporate, households can fund in euro, whereas if you’re in Brazil or many other emerging markets, it’s difficult to raise international funding in your local currency essentially you’re mostly reliant on dollar funding.
So the transmission to Europe is both direct - there is obviously a lot of intersection between the US and European financial system - but a lot of it is going to be indirect. I think one of the big stories for 2016 is the trajectory for emerging markets, that even relative to ‘07 emerging markets are a much bigger part of the world economy now because they’ve grown so much more than the advanced economy so, again, my background in global macroeconomics and finance makes me quite aware that in thinking about the prospects for Europe, that that’s very much conditioned on prospects for the world economy and the world financial system.
How do you see the world economy, with all of that in mind?
“I think the main point there which I think is generally shared is there’s an unusually high amount of uncertainty at the moment. The US is raising rates because the US economy is recovery, so the good news story there is they only raise rates because the economy is growing in a robust way and that’s good for Irish exporters. So at that level that’s good news. It’s good news that the European economy is recovering. It’s important to signal that low oil prices have been an important source of support for the European economy. But at the same time if the emerging markets go through a substantial slowdown that can have effects on global trade and can effects on the global financial system because the emerging markets have issued a lot of debt, mostly non-sovereign, there was a lot of corporate debt in recent years .The global interconnectedness of the financial system is such that we have to be attuned to the possible shock effects from that.”
We say this in a backdrop where markets were suspended in China. In other words, this matter is in the here and now?
“It’s true also to have a measured and a differentiated approach to that. If you divide the emerging economies into different groups: Those economies like China which have a long sequence of external surpluses, have a large bank of foreign reserves, they have a lot of policy instruments to deal with any problems that emerge. Whereas those economies such as Brazil which have been running external deficits and which basically do have a heavy reliance on foreign currency debt, are much more vulnerable. China is obviously making a transition from an investment driven economy - where there was possibly some overbuilding in real estate and so on - it has to manage the transition from that to more of a consumption driven economy and of course economies of that size are going to slow down. So there are big transition issues in China but I think there’s also a lot of policy space for the Chinese authorities to intervene.”
Did you always want to be the governor of the Central Bank? Does anyone grow up wanting to be the governor of the Central Bank?
“I think it’s fair to say that definitely the tradition of the world I was in, in terms of the Harvard economics background, is that very definitely there’s a lot of mobility between academia and public service. So I’d view it as not uncommon for someone like me to make that move. Many of my cohort have made similar moves so it’s not totally foreign to make that move.”
Have you had dealings with Michael Noonan?
“I have met him twice. After the job [appointment] and general update in mid-December.”