The Impact of US Policy Innovations on Central Banking Policy in Europe

1st July 2025

Patrick Honohan discusses how shifts in US policy may transmit to the global financial sector

The sequence of startling policy demarches unrolling from the White House are putting the spotlight on financial policy makers in Europe and the rest of the World. It is in the nature of systemic financial crises that they come as a surprise and contain novel elements that have not been seen before. Several remarkable dimensions of US Government policy this year certainly change the environment for internationally active firms around the world, increasing risks that may transmit to the financial sector, there to be amplified and potentially feed forward into a systemic crisis.

To date, though there have been some remarkable movements in asset prices, the global impact has not yet been felt. It is a lull before the storm. 

Three separate dimensions stand out in particular.

• For central banks, there is the challenge of ensuring that demand conditions and price stability are maintained – the bread-and-butter of monetary policy choices.
• Second, a sense of heightened vigilance pervades among financial authorities charged with crisis prevention and crisis containment.
• And for the longer term planning, the fading role of the US dollar as anchor of the international monetary system has accelerated thinking about whether a multipolar system can be stabilized. 

In all three of these dimensions the question arises as to how much can be hoped for in terms of cooperative action by US financial authorities. 

Twice in the past two decades we have seen global financial sector turbulence emanate from the United States. But, both in 2008 and 2020, the US Administration and its financial authorities could be relied upon to respond imaginatively to the sudden stop, and that their response would be taken in full communication with the authorities in Europe. 

But now, as several of the personalities in charge have changed in line with the Administration—and as others will also no doubt be replaced when their current terms expire, what can we expect in terms of crisis prevention and containment? Given what we have heard from some senior US officials, is it unduly alarmist to wonder about the degree to which a new crisis affecting Europe could not only emerge from policy developments in the United States, but that this time the corrective action to contain the crisis might not be conducted by the US authorities in ways that protect the European financial system and its economy?

After all, up to now there has been a largely shared transatlantic understanding both of the mechanisms of monetary and financial policy and of the advantages of seeking a cooperative solution to the challenges of dealing with financial instability in a world of international interdependence.  Will that remain the case as White House-inspired personnel policies extend their reach? 

Already the Chairs of the FDIC and the SEC have resigned, though the circumstances have been different in those cases. The Consumer Financial Protection Bureau (CFPB) is being dismantled. The Chair of the Federal Reserve Board is still in place, though his term ends within a year. Other top decisionmakers at the Fed still have long terms ahead of them, so it might seem premature to be expecting a sea-change in the approach to policy. However, with repeated aggressive criticism of the Fed’s monetary policy stance from the White House, it would be Panglossian to assume that internationalism would be to the fore at the Fed in the years to come. If the hegemon retreats, how should others react?

Monetary policy

Despite the evident impact on trade and economic activity of the use, by the US Administration, of disruptive tariff announcements and negotiations, and despite the remarkable degree of uncertainty as registered by market prices as well as news-flow and commentary, macroeconomic conditions have not yet markedly deviated from their already anaemic path. To take the eurozone in particular, the latest monetary policy assessment of the ECB actually looks like an equilibrium situation: inflation expectations over the three years 2025-7 average 2.0 per cent. The policy rate (which, because of ample liquidity is now the ECB’s deposit rate) at 2 per cent – down from 4 per cent in just one year, with a sense that there is little of any more decline expected, implying an R-star of zero.  No signs of panic here. What’s not to like? Steady as you go! 

It’s an understandable position: having been burned by hawkish mistakes in 2008 and 2010, the ECB was a bit late off the mark when the inflation whiplash took hold, but it has wrestled inflation down effectively. It started by underestimating the inflation and then overestimating it. Now, in line with the fashion advocated by Ben Bernanke in his (2024) report on the Bank of England’s forecasting practice, there is more use of scenarios by the ECB. No doubt, more extreme scenarios are also being explored in the background, but the two scenarios that the ECB has published in its most recent projections are not extreme, and look more like one standard-deviation around the central forecast. 

But this is more like stasis than stability. The ECB’s central forecasts imply continued low GDP and productivity growth in the coming years. Against that background, the disruptive policy innovations in the US could trigger insolvencies of financial or non-financial firms in European (or other) countries, spilling over into a generalized loss of confidence of the type that calls for crisis containment by the central bank (Honohan 2024).

Between monetary and financial stability policy: asset purchases 

If and when the storm arrives, a central question will be whether and how asset purchase should be used. There have been two (and a half)  main uses of this tool in the euro area.  The first big use was from 2015 to dodge deflation (and let’s face it) to juice the post euro area crisis recovery. The second use was from March 2020 to respond to the dash for cash and the collapse of economic activity at the start of the pandemic. 

The financial stability and conjunctural goals for QE are really quite different. I am not sure that this distinction was everywhere understood in 2020. Kashyap et al. (2025) have recently provided a very shrewd analysis of the particular trades that went wrong in March 2020 and caused the US Treasury bond market to freeze; they point out that a more carefully targeted intervention could have been used to unblock the market by using more of a scalpel than a shovel in relation to the particular trades that had gone wrong. That would not have required as large an intervention that occurred and that left the money market awash with liquidity. With the benefit of hindsight, this analysis suggests that QE was an unduly blunt tool. More targeted action (along with better targeted fiscal measures) could have dealt with these and other pandemic-related income problems with much less liquidity provision from central banks. The ECB was part of this herd, following in the slipstream of the Fed.  Next time, things might be different. A dash for cash might not be towards the US, but away. The Fed’s response would be less predictable. Other central banks will have to decide to what extent they should move in line with, or in contrast to, whatever the Fed decides. 

The Bank of England is actively reducing its asset portfolio, while the ECB is allowing the stock of QE assets to run off (cf. Du et al. 2024). But one can easily imagine the need emerging in a future episode of financial instability for a renewed use of asset purchases by the ECB. But I expect it to be more targeted and, when used to neutralise a financial market disruption or panic, its goals better argued.  Evidently, when it comes to QE, fiscal dominance is going to be a threat.  With governments pressed to spend more money on defence (thanks to the new attitude of the US Administration to NATO) and on infrastructure/climate policies, they will have difficulties in selling all the bonds they want at a reasonable price.  The ECB will likely be facing some hard choices in that context.

Crisis containment

Cross-border aspects are an inevitable feature of any future systemic financial turbulence. When the financial “sudden stop” comes, the central bank can step in with open-ended provision of its own currency, as was the case for example in Switzerland during the run on the large bank Credit Suisse. But no central bank apart from the Fed has an unlimited capacity to provide US dollars when there is a run away from the domestic banking system and towards that, traditionally safe-haven, currency. Especially in 2008 and 2020, swap arrangements between the major central banks have helped expand their access to US dollars, allowing them to provide emergency liquidity facilities in US dollars to their banks to meet outflows. Given some of the rhetoric that has come from the White House in terms of cross-border assistance along various dimensions, many observers have expressed concern that the existing swaps arrangements might be curtailed from the US side. Of course, the provision of swaps is not a wholly altruistic act: failure to provide swaps can be expected to transmit the turbulence of a bank run across borders into the US financial markets as the scramble for cash will not respect jurisdictional boundaries.  This was well understood in 2008 and 2020, but with the new suspicion in Washington DC of international entanglements, it is not unreasonable to be apprehensive that swaps will not be as readily available in a future crisis as they have been up to now.  To be sure, central banks do hold substantial foreign currency assets, and these could be used (especially if the network of swaps was repurposed to envisage cross-border lending between central banks of their US dollar and other foreign currency assets—cf. McCauley 2025).

The future of the dollar in the international monetary system

It is hard to avoid the perception that recent institutional innovations in the US will have a lasting and irreversible adverse impact on the standing of the US dollar as a risk-free asset. Partly, of course, this is also a debt sustainability story, as is evident from a glance at the authoritative projections that have been showing rapid and accelerating increases in the US Federal Government debt ratio. The financial sanctions on Russia have also contributed to discourage international dollar holdings. But the reckless conduct of the White House this year is the major accelerant. Absent a sharp reversal of the current expansionary fiscal policy or an implausibly favourable medium impact of AI and the deregulatory policies of the US Administration, the unrivalled standing of the dollar and America’s “exorbitant privilege” must be inexorably eroding. 

The future international monetary system will, therefore, not be dollar dominated as it has been, because the dollar that we have now is not the dollar as we knew it in the past (supported by unrivalled hegemony of the United States and its seemingly stable constitutional and legal arrangements). 

Thus, the prospect is of a multipolar global monetary system with the euro and (eventually) the Chinese Renminbi assuming ever greater roles. Exchange rate movements between major currencies are likely to be more volatile. Shifting trade patterns will make invoicing in partner currencies rather than the US dollar increasingly attractive, and this in turn will lead to an accelerating move away from the dollar in transactions portfolios. While many bilateral exchange rate transactions will still use a intermediate vehicle currency offering sufficient liquidity, the dollar will lose its dominance with a couple of other currencies joining it. The preferred currency denomination of asset holdings will shift in line both for this reason and because of heightened market (and even credit) risk. 

While this logic suggests that trade weights will be influential in determining which currencies are likely to have an important role in this future multi-polar system, it would be foolhardy to speculate on how many poles will be significant.  However, another development in current US policy points to a potential additional factor, namely the growth of stable-coins (Aquilina et al. 2025). While it is clear that the use of these instruments has been predominantly as vehicles for transactions in crypto-assets (much of it probably associated with illegal activities), the reduced transactions costs, relative to the correspondent banking system, and the lighter regulation that is foreseen in the US, suggest that market observers who foresee a rapid growth in their use are not being unrealistic. 

Could one or two private stablecoins, potentially anchored (using readily available software) to novel numeraires or currency baskets, begin to play a central role as part of the multi-polar regime towards which the momentum is building? If turbocharged by official US enthusiasm, this does not seem impossible, especially if the stablecoins offer attractive ways of earning interest. These shifts will respond to convenience and risk-reduction in choice of invoicing currency and in payments. With private stablecoins keen to increase market share, the position of the euro will likely depend on the ECB’s ability to position an efficient CBDC in the market.  The ECB started well in preparing for this, but the initial plan is too tentative and constrained, both in regard to remuneration of the digital currency and ceilings on holdings.  A euro-CBDC that works for small businesses and for a larger share of retail payments will become necessary sooner than we thought.

Conclusion

Cordial cooperation has been a feature of international central banking relationships for the past century, facilitated by well-attended bi-monthly meetings at the Bank for International Settlements. It has not always been plain sailing, but the evident threats from the new regime in the United States could move matters into a new dimension, with the role of the US financial policymakers less dominant, and a greater interest among others to collaborate on ensuring that shocks from the United States do not destabilize the rest of the world’s monetary and financial systems.

References

Aquilina, Matteo, Giulio Cornelli, Jon Frost and Leonardo Gambacorta. 2025. “Cryptocurrencies and Decentralised Finance: Functions and Financial Stability Implications.” BIS Papers No. 156.

Bernanke, Ben S. 2024. “Forecasting for monetary policy making and communication at the Bank of England: a review.” Bank of England.

Du, Wenxin, Kristin Forbes and Matthew N. Luzzetti. 2024. “Quantitative Tightening around the Globe: What Have We Learned?” NBER Working Paper 32321.

Honohan, Patrick. 2024. The Central Bank as Crisis Manager (Washington DC: Peterson Institute for International Economics). 

Kashyap, Anil K, Jeremy C. Stein, Jonathan L. Wallen and Joshua Younger. 2025. “Treasury Market Dysfunction and the Role of the Central Bank.” Brookings Papers on Economic Activity (forthcoming).

McCauley, Robert N. 2025. “Avoiding Kindleberger’s Trap: A Dollar Coalition of the Willing.” Voxeu May 5.