FT premium subscribers can click here to receive Free Lunch every day by email
It has been a chaotic week in politics, with coronavirus disruptions around the world, a big off-calendar interest rate cut in the US and a revived migration crisis in Europe. But do not lose sight of the important slower-moving changes behind them, such as policymakers’ intensifying attempts to slowly turn the supertanker of finance in a greener direction.
Sabine Mauderer, a member of the Bundesbank’s executive board, wrote in the Financial Times last week about the need to incorporate the climate change threat in central banks’ risk assessments. Her op-ed coincided with the launch of the “COP26 Private Finance Agenda” supported by Bank of England governor Mark Carney and European Central Bank president Christine Lagarde.
The big question is not if or when central banks incorporate climate change considerations in their operations, but how. There are two very different ways central bankers could think about their role in an age of rapid and risky climate change.
The first approach is to build the basic economics of climate change — the many “negative externalities” of carbon emissions — into standard central bank analysis. This means, for example, taking into account the risk to asset prices from either devastating climate change or policy actions taken to avoid it (such as forcing oil companies to leave oil in the ground), or including the impact of climate change and the economic upheavals it brings in models of how inflation is generated. Such analytical moves, while taking better account of the economic reality, can alter monetary policy choices, collateral valuations, banking supervision and more.
The second approach to address climate change also starts by recognising that climate risk is mispriced in economic and financial markets, but then goes further and seeks to change that. As finance is “greened” and investors differentiate between investments that help or hurt the decarbonisation effort, they can also measure the difference in financing costs between “green” and “brown” activities. Call it the “green spread”. A way to conceptualise this second approach is to think of central banks as not merely taking the green spread into account analytically (as in the first approach), but actively targeting it. Widening the green spread, for example, would correspond to shifting financial resources from brown to green activities.
Which of these two approaches should central banks adopt in their recognition of climate change? Should they just recognise the green spread or try to affect it? I think this is where the intellectual and political battles will rage in the next few years, and this may start even in the monetary policy reviews now being undertaken by several leading central banks.
Mauderer’s op-ed, for example, advocates the first approach. She writes: “Unlike private sector banks, central banks follow the principle of ‘market neutrality’. This means that, when implementing monetary policy, they must not seek to distort markets’ price-discovery mechanism. Giving preferential treatment to certain industrial sectors or bowing to social pressure runs counter to this principle.”
Karen Ward of JPMorgan, in another FT op-ed, envisages the bolder approach of giving up on market neutrality. She writes: “Central banks are increasingly being asked to deliver growth that is ‘balanced’. So in the fullness of time, we should expect central banks to be asked to deliver stronger, yet greener, growth.”
This is a debate about what central banks should do, not what they can do. There is no shortage of tools a central bank can use to affect the green spread if it wants to — as Ward suggests, it could direct asset purchase programmes towards green assets such as the infrastructure needed for a zero-carbon economy. Targeted bank lending programmes could also be conditioned on channelling central bank liquidity to green purposes.
The ECB, in particular, is well placed to take the more ambitious approach. So long as it achieves price stability, the euro’s central bank is treaty-bound to support the economic policies of the EU, which includes sustainable development, the European “green deal” and, soon, a legal commitment to carbon-neutrality by 2050. And the European Commission is working on a “taxonomy” of assets that would help establish degrees of climate-friendliness, and hence price the spread between them.
A move in this direction would no doubt cause controversy. But the flip side of this is that virtually all central banks can be expected to adopt at least the first approach without much resistance. That is already quite something.
Other readables
- The OECD’s latest Economic Outlook is a very good and succinct analysis of the possible economic fallout from the coronavirus epidemic. In a severe scenario, it estimates that global economic growth could halve to 1.5 per cent this year. But it also emphasises that economic policy can respond and offset much of this risk to growth.
- The Federal Reserve delivered an emergency larger-than-usual interest rate cut this week. In an Instant Insight comment piece I explain why it did the right thing.
Numbers news
Source: Economy - ft.com
