##preciate that domestic real interest rates can temporarily move away from their international counterparts. furthermore, what we understand much more clearly these days is that movements in the real exchange rate are a major part of the process whereby an economy returns to a sustainable growth path after being hit by a shock. for example, it is well known that a drop in world commodity prices reduces the real equilibrium value of the canadian dollar. if this is brought about by currency depreciation, the overall domestic price level need not deviate from its target path. in contrast, with a fixed exchange rate, domestic prices would have to fall below that path, and perhaps fall absolutely, to bring about the required decline in the real exchange rate. it is clear that real exchange rate adjustment works much more smoothly when the nominal exchange rate can adjust. however, for the benefits of exchange rate flexibility to be realized, expectations about nominal exchange rates must be anchored by a monetary policy that is focused on maintaining low and stable inflation over the medium term. 4. increased confidence in the resilience and efficiency of markets it would have been unthinkable in the 1960s to have suggested that the central bank ’ s influence over interest rates was, in and of itself, enough to enable it to keep the rate of inflation low and stable. the view at the time was that there were narrow bounds on how far interest rates could be moved, and that these severely limited what the central bank could accomplish by varying them. as a result, moral suasion to affect bank lending policies or direct controls were seen as important additional instruments for central banks. a key reason for the change in attitude today is an increased confidence in markets. certainly, at central banks, we are more confident than we were in the 1960s of the ability of financial markets to absorb changes in interest rates. at the same time, we have accumulated strong evidence to support the view that market mechanisms transmit monetary policy actions effectively. in the 1960s the porter commission was ahead of the bank, and of conventional wisdom, in this. it envisaged a monetary system that in key respects would function much as it does today – driven by market forces, flexible, and frequently undergoing rapid change. in its recommendations for reform, the commission was looking forward to a world in which monetary policy would be increasingly reliant for its effectiveness on appropriate movements in financial market prices. in line with this view, the porter report maintained that institutions and markets were well able to withstand substantial shocks and warned against

patrick honohan : critique of the financial crisis decisions of endseptember 2008 – my views introductory statement by mr patrick honohan, governor of the central bank of ireland, at the oireachtas banking inquiry, dublin, 11 march 2015. * * * in my letter of february 12, i sought to clarify parts of my evidence to the inquiry on january 15. i have prepared these short introductory remarks on the presumption that the inquiry has invited me back on this occasion to amplify my views on the alternative courses of action that might have been taken by the government at the end of september 2008. perhaps i should recall explicitly that i myself had no involvement in the guarantee decision. so my views are based on what i learnt from preparing my may 2010 report on regulatory and financial stability policy, as well as on many conversations with other experts and on my general knowledge of banking crises in other countries. critique of the decisions of end - september 2008 there are several features of the decisions at end september that can be criticised even allowing for the limited information then available to the decision makers. • first, the guaranteeing of some of the subordinated debt. providing an explicit guarantee to subordinated debt holders is not only potentially costly to the state but undermines the rationale for allowing banks to meet part of their regulatory capital with subordinated debt. this was a definite design flaw. true, thanks to steps subsequently taken, the payout to subordinated debt holders of anglo in the end was a small proportion of the total fiscal cost ; however, they were not negligible. • second, guaranteeing existing outstanding debt ( senior bonds and term deposits ). this was not necessary to underpin the banks ’ continuing access to funds. nor did the government guarantees introduced by other countries in 2008 offer any significant backward looking protection in this way. it is true that imposing losses on such bondholders would have had a damaging reputational effect on ireland as a whole, as well as impacting local holders of such bonds ; but that is a different question. the decision to impose such losses could not have been lightly taken ; but offering a pre - emptive guarantee on already outstanding ( “ old ” ) debt ahead of a full assessment of what it might cost was essentially gratuitous. furthermore, because much of this debt entitled the holders to immediate accelerated repayment in “ an event of default ”, the government were effectively precluded from liquidating or extensively restructuring the guaranteed institutions