Evolving Central Bank Thinking: the Irish Central Bank 1943 to 1969

Evolving Central Bank Thinking: the Irish Central Bank 1943 to 1969

Ella Kavanagh[1], Dept. of Economics, University College Cork, Ireland

Abstract

The lens through which a Central Bank views the economy and macroeconomic policy affects their analysis of economic performance, their assessment of government policies, their role as policymakers and ultimately economic growth and performance. Economic ideas matter. In keeping with this idea, this paper examines how the thinking of the Irish Central Bank, evolved over a period of major transformation (1943-1969) in the Irish economy and intellectual developments in monetary theory and policy. In doing so, the paper seeks to address the gaps identified by Brownlow (2010) in our understanding of “the precise intellectual influences on the development of the Bank’s economic thinking” and to evaluate whether or not “Ireland’s monetary authorities merely copied British policy practice rather than considered the implications for Ireland of the emerging academic research within monetary economics” (Brownlow 2010, p. 320)

This paper adopts an interpretivist approach to the Bank’s Annual Reports from their introduction in 1943 until 1969 to uncover the Bank’s evolving thinking. In this regard, it extends the narrative work completed by Moynihan (1975). We adopt the view that the annual reports, in terms of the data that the Bank collected and published, the evidence it used, its analysis and its commentary on the Irish economy and international events reveal evolving thinking and understanding of how monetary factors affect the economy, how government policy interacts with monetary matters and the role of the Bank and monetary policy in a small but open economy. Where relevant, we also support our analysis with archival research.

Our preliminary analysis points to an evolution in the level of analysis, critique and the application of economic ideas. Although the Bank’s governors were initially influenced by UK Treasury thinking, they were also guided by international economists. We note that over time the Central Bank became progressively shaped and influenced by international academic developments in monetary theory and policy, which repositioned them away from UK monetary thinking.

While the Central Bank Act 1942 required the Bank to “publish informative material” regarding monetary and credit problems, we find that the content of the reports evolved very rapidly. The Governor (and subsequent governors) began to publish an annual report immediately and by the second report, the Bank had started to comment on macroeconomic conditions. By 1947 the Bank’s Report began to comment on government policy. In this regard they provide clear evidence that the Irish Central Bank differed significantly in how it perceived itself and its role, from the Bank of England at this time. The latter’s reports did not include either analysis or commentary as it wished to ensure that its interpretation of events and their exposition of current problems, would not cause embarrassment to the government.

Key Words:

Central Banks; Development; Monetary History; Economic Thought; Policy;

Introduction

This paper examines the evolving economic thinking of the Irish Central Bank over the period 1943 to 1969. The Irish Central Bank Act was passed in 1942 twenty years after independence from Great Britain. As Schenk (1993) has noted along with the administrative trappings of independence most former colonies wished to establish institutions that they believed would give them more sovereignty over their own economic policymaking. The Commission of Inquiry into Banking, Currency and Credit (hereafter known as the Second Banking Commission), which reported in 1938, was assembled to investigate the changes that were necessary or desirable“to promote the social and economic welfare of the community and the interests of agriculture and industry”. They recommended the establishment of a central bankto replacethe Currency Commission, a bank of issue set up after independence to issue Irish Pounds in exchange for sterling.

The Central Bank Act (1942) laid down the general duty and functions of the new Bank:

“The bank shall have the general function and duty of taking such steps as the Board may from time to time deem appropriate and advisable towards safeguarding the integrity of the currency and ensuring that, in what pertains to the control of credit, the constant and predominant aim shall be the welfare of the people as a whole”.

The lens through which a Central Bank views the economy and macroeconomic policy affects their analysis of economic performance, their assessment of government policies and their role as policymakers and ultimately economic growth and performance. Economic ideas matter. Both Romer (2007) and Batini and Nelson (2005) uncover the changing economic ideas in the Federal Reserve and in the Bank of England respectively and the impact that these new ideas had on macroeconomic policy.

In keeping with this idea, we examine how the thinking of the Irish Central Bank, evolved over a period of major transformation in the Irish economy and intellectual developments in monetary theory and policy.

We adopt an interpretivist approach to the Bank’s Annual Reports from their introduction in 1943 until 1969 to uncover the Bank’s evolving thinking and policy. In this regard, we extend the narrative work completed by Moynihan (1975). The annual reports, in terms of the data that the Bank collected and published, the evidence it used, its analysis and its commentary on the Irish economy reveal evolving thinking and understanding of how monetary factors affect the economy, the relationship between the Bank and the government and the role of the Bank and monetary policy (including their instruments) in a small open economy. We also where relevant, support our analysis with archival research.

This paper specifically places the Irish Central Bank in an international context. As a former colony of Great Britain, the close contacts between the two countries and the fact that many of the personnel working in the newly created Irish civil service had already worked in the British administration meant that many of the new institutions in Ireland, such as the Irish Exchequer, were modelled on British lines. We question whether this was also the case for the new Central Bank and whether it continued to be influenced by Treasury and Bank of England thinking or became increasingly shaped by international academic developments in monetary analysis and policy in line with the more outward looking orientation of the economy.

In doing so, the paper seeks to address the gaps identified by Brownlow (2010, p. 320) in our understanding of the “precise intellectual influences on the development of Bank’s economic thinkingand to evaluate whether or not Ireland’s monetary authorities merely copied British policy practice rather than considered the implications for Ireland of the emerging academic research within monetary economics”.

This paper is organised as follows. Section 2 explores the developments in monetary policy internationally over the period 1930-1969. We review monetary policy developmentsin the UKin order to provide a context for policy developments in Ireland. We also reference key developments, individuals and institutions, in international monetary economics, which we argue did impact on the formation and the evolving thinking of the Irish Central Bank. Section 3 provides a brief biography of the three central bank governors, Joseph Brennan,J.J. McElligott and Maurice Moynihanas their background may have affected their willingness to adopt new ideas. Section 4begins with a discussion of the international influences on the formation of the Irish Central Bank and Section 5 then proceeds to followthe evolving thinking of the Irish Central Bank through the reports. Section 6 provides an overall assessment.

International Monetary Developments
The Gold Standard and the Classical Perspective

Prior to World War 1 (WW1) the world economic order was built on the gold standard and free trade. At the centre was the City of London and the Bank of England. Monetary policy, that did exist, was targeted towards preserving the gold convertibility of the pound, promoting the international standing of London and protecting the soundness of the domestic banking system in its role as lender of last resort (Collins, 1988, p. 268). The Bank Rate[2] was the instrument used.Maintaining gold convertibility effectively tied the hands of the government and consequently over this period the Bank of England enjoyed significant autonomy from the government.

After WW1, the Cunliffe Committee (1919) recommended that Britain return to gold after the wartime suspension. This course of action was favoured by both the Treasury and the Bankof England. The economic and financial ethos of the Treasury in the 1920s was built on the interlocking triad of sound finances, the gold standard and free trade (Clarke, 1990, p. 168). The Treasury adhered to the Classical principles of a balanced budget and a limited role for the state. Taxes were considered as a burden on productive enterprise implying that government expenditure should be kept low and confined to essential activities. In fact, the aim should be an ex post budget surplus to permit the repayment of debts (Middleton, 1982, p. 51). Borrowing was not encouraged as ittook resources away from the private sector. Only two exceptionswere allowed - to finance capital projects that were remunerative in an accounting sense and during wartime.In line with classical thinking budget deficits were regarded as inflationary (Middleton, 1982, p. 53). The second part of the triad, the gold standard, was favoured by the Treasury as the simplest and most direct way of achieving a high degree of economic stability.

The Bank of England believed that the revival of the gold standard, by facilitating international trade and investment, was the only way in which pre-war prosperity could be restored. The Bank did not believe that it had the capability to affect economic conditions. They also considered that the monetary discipline resulting from adherence to the gold standard was essential to the maintenance of low inflation. The hyperinflation episodes in Germany, Austria and Russia and the Latin Countries in the 1920s provided strong evidential support for the danger of management without gold (See Moggridge, 1972, p. 86).

The international community also conformed to the prevailing doctrine of liberalism and laissez-faire in economic affairs (Collins, 1988, p. 279). The gold standard mentalite[3] was deeply engrained in the minds of government ministers, treasury officials and central bankers. At the International Financial Conference at Brussels in 1920 organised by the League of Nations, countries were encouraged to balance their budgets, combat inflation and work towards the re-establishment of the gold standard (Singleton, 2011, p. 58). They also recommended that banks of issue (Central Banks) should be established in those countries, which did not have them and should be unfettered from the government so that they could conduct their activities based on the principles of sound finance (Jacobsson, 1979, p. 41). The experience with floating exchange rates in the early twenties reinforced the belief that the alternative to autonomouscentral banking was monetary chaos, exchange-rate volatility and, ultimately, hyperinflation (Eichengreen and Temin, 1997, p. 25).Great Britain re-joined the Gold Standard in 1925 followed by France in 1928.

Membership of the Gold Standard was not a success and Britain was forced off gold in 1931, followed by the US in 1933 and France in 1936. The periodic currency crises meant that many international conferences organised during the 1930s called for the restoration of exchange rate stability. The Imperial Economic Conference of commonwealth countries held in Ottawa in 1932, the World Monetary and Economic Conference in London, convened by the League of Nations, in July 1933 and the Tripartiteagreement (between Great Britain, France and the USA) of 1936, all recommended the restoration of stability in the exchanges.Importantly to ensure the return to goldthe 1933 conference reiterated the call for independent central banks, with the freedom to set appropriate credit and currency policy, to be established in all developed countries (Moynihan, 1975, p. 198).

In contrast to the exhortations by the League of Nations for independent central banks, the departure from gold had a fundamental impact on the relationship between the Bank of England and the Treasury. Prior to WW1 the Bank of England was technically independent from government. However, links between the Bank of England and the Treasury had become stronger during WW1. The Bank of England was responsible for the sale of government bonds and treasury bills to generate the necessary finance for war-time needs. The Bank also made direct loans to the government from its own account (Collins, 1988, p. 273). This closer relationship between the Bank and the Treasury continued after 1918,with greater interference by the Chancellor of the Exchequer in the Bank of England’s affairs, in particular the setting of Bank Rate. “In fact, in almost every instance of pressure on sterling in the course of the interwar gold standard, the Treasury appears to have made its views known against an increase in existing rates” (Moggridge, 1972, p. 162). Rises in the Bank Rate were aligned to increases in unemployment and industrial problems and changes in the rate were assumed to have considerable effects on public expectations and confidence. Consequently, interest rate setting became increasingly politicised during this period. This meant that another policy instrument i.e. moral suasionhad to be used to deal with reserve crises and pressure on sterling as the trust in free trade ruled out direct intervention on the trade account to reduce imports at least until the adoption of tariffs in 1931-32 (Moggridge, 1972, p. 165).

Once the gold standard was abandoned, an immediate redistribution of authority and responsibility took place between the Bank of England and the Treasury (Kynaston, 1995, p. 28-9) and throughout the 1930s, the Treasury and the Bank cooperated more closely than before (Collins, 1988, p. 293). In general, central bankers who had adhered strictly to the rules of the Gold Standard found themselves having to work much more closely with their governments once they had come off gold. Singleton (2011) refers to this period, from the mid-1930s to the late 1940s, as the first revolution of central banking involving a “partnership” between central banks and their governments.

2.2.The1930s and 1940s: Greater Intervention - Cheap Money and Keynesianism

The 1930s, the depression years, introduced a new monetary era – “cheap money” which was the main plank of Britain’s domestic economic strategy. Developments in monetary theory in these years e.g. Robertson, 1926 and Keynes, 1930 concluded that low long-term rates were needed to increase investment in fixed capital whereas low short-term interest rates would boost investment in working capital (Howson, 1989, p. 94). This “cheap money” policy would have the added benefit of reducing inflows of hot money and the interest costs of government debt (Collins, 1988, p. 297). At the short end of the market, the Bank Ratedeclined from 6% to 2% by June 1932 and it remained at this level until 1951. Long-term rates (yields on consols) fell from 4% at the end of 1931 to under 3% by the close of 1934 (Collins, 1988, p. 298). By 1938, the average long-term rate for that year was 3.38%.

During the 1930s, the traditional peacetime position of controlling government expenditure and budget deficits continued to hold sway in the Treasury. Central to the economic policy debate of the time, was the view that budget deficits would have a negative effect on business confidence, especially if they resulted from unremunerated public works (Middleton, 1982, p. 32). The Treasury also expressed concern that breaking the budgetary rule would set in train explosive expenditure increases and increasing state powers “especially if the borrowing for current expenditure was advocated as the road to prosperity” (Middleton, 1982, p. 59). However, during this period there was a change in the Treasury’s view on inflation. Unlike monetary financing, they no longer considered borrowing from current savingsto be inflationary (Middleton, 1982, p. 56). By 1937, theirthinkingon government expenditure had changed significantly. A consensus had developed amongst economists and a great many politicians of differing party allegiances that planned public workscould be an effective stabilisation measure. The Treasury were consequently prepared to act in this direction (Middleton, 1982, p. 70).

WW2 continued the high level of collaboration between the Treasury and the Bank of England and state control towards the war effort. In fact, Fforde (1992, p. 320) states that at the end of the war it is “not much of an exaggeration to say that …. the British central banking function with respect to the formation of domestic monetary policy had come to rest almost entirely in a Treasury well enough versed in monetary economics, while its technical execution, of which the Treasury knew very little, fell to the Bank of England whose skills were confined to market management and whose dexterity in monetary economics, remained little used outside Threadneedle Street”.