Central Banks, economic stability and social capital: what’s the connection – Governor Gabriel Makhlouf

16 February 2023 Press Release

Central Bank of Ireland

Governor of the Central Bank of Ireland Gabriel Makhlouf today (16 February 2023) delivered a keynote lecture at an event hosted by London School of Economics Law School. 

Speaking at the event, Governor Makhlouf said: “There are many definitions but I like to think of social capital as the social connections, attitudes and norms that contribute to societal wellbeing by promoting coordination and collaboration between people and groups in society. Central banks need trust to succeed. 

As I have said before, I believe that credibility and trust are essential elements for monetary policy to be effective.  Central banks and regulators have a key role in ensuring the integrity of the regulatory and supervisory frameworks which safeguard the stability of the financial system, and the protection of consumers. 

The independence of central banks is vital in this and I am acutely aware that we, central bankers, are not elected officials, but are assigned with a task – price stability – that is fundamental to the wellbeing of our citizens. This requires that we be held accountable for our actions, and act transparently at all times.  Independence is not just a given, it has to be earned and maintained.  And this means delivering on our price stability mandate in the first instance, and also communicating clearly the rationale for our policies.

A failure to deliver on its mandate destroys trust and credibility in the central bank. In Ireland, we saw this during the financial crisis, when a lack of sufficiently robust financial regulation was identified as a key failure contributing to the banking sector collapse. It was a long road back for the Central Bank, in terms of rebuilding trust, requiring significant reforms, notably introducing a robust macroprudential policy regime, significant reforms to our regulatory approach and framework, and building a consumer protection framework that is more responsive to emerging risks.  

Trust and credibility in central banks has taken another buffeting from recent high inflation.  And, while headline inflation has declined from its end-2022 highs, in part thanks to lower energy prices, I believe we still have a way to go to return inflation sustainably to our 2 per cent target.

Persistently high inflation erodes our economic capital.  If households, firms and financial markets no longer trust in the ability of the central bank to deliver its inflation target, we will see medium-term inflation expectations begin to drift above it. 

High inflation also erodes the other types of capital.  Without a high degree of trust in the value of our currency, households and firms will be reluctant to undertake the kind of long-term investments that can help to build human and physical capital.  Financial capital is at risk when borrowers’ resilience is threatened by rising prices and interest rates. 

An increasingly unequal distribution of income and wealth is another factor that can erode social capital, with potentially devastating effects for the level of trust that citizens have in their public institutions, including the central bank. While central banks have neither the mandate nor the most appropriate tools to deal with societal concerns around income or wealth inequality, they can help build social capital through their actions and by continuing to focus on fundamentals.

Credibility requires that a central bank’s objectives are clearly defined and monetary policy action is not influenced by conflicting goals. Expectation-setting requires a central bank to communicate clearly both its objective and how it intends to achieve it. This requires, in turn, that the public understand the mission of central banks, recognises the importance of that mission, and trusts in its commitment to deliver. 

I take these issues of trust and credibility extremely seriously and that is why I am glad to be here today – as a public servant and central banker, it is my job to be open, to be transparent and to communicate what we are doing and why.”