Central banks are thinking greener as climate change hits policy

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Climate change is increasingly affecting the world’s central banks and their monetary policies.

At a time when students around the globe are urging governments, companies and citizens to protect the environment, awareness is growing among currency guardians that weather disruptions, carbon emissions and green finance will demand significant attention.

Freak weather events blamed on global warming — largely regarded as temporary shocks so far — risk becoming serious impediments to economic management in the future. They could even require a rethink of central-bank mandates at some point. But officials aren’t only on the receiving end: Their policies to support growth also have the potential to contribute to a greener planet.

Below, we run down papers that highlight the challenges central banks face in addressing climate change:

Disruption caused by extreme weather events and attempts to mitigate them make forecasting the economy increasingly difficult, according to a Brookings Institution discussion paper. That’s what happened in Germany at the end of last year when low water levels on the Rhine river caused unexpected transport bottlenecks and slowed growth.

Researchers argue that nominal income rather than inflation targeting could turn out to be a better strategy because it doesn’t require policy makers to understand the precise nature of the shock and relies less on potentially imprecise projections.

CLIMATE CHANGE, FINANCIAL STABILITY AND MONETARY POLICY
Central banks including the European Central Bank and the Bank of England have put a particular focus on financial stability when it comes to climate change, helping set standards for financial disclosures and green assets classification.

A paper published in Ecological Economics argues that a push toward more environmentally friendly technologies could bankrupt companies that rely too much on coal and saddle banks with bad debt. Resulting portfolio shifts could lead to a decline in corporate bond prices, with volatility hurting credit growth.

The researchers argue that policy makers could reduce instability by purchasing green corporate bonds, and a simulation shows that if they buy a quarter of all outstanding such securities in 2020 and commit to maintaining that share for decades, they could even slow global warming.

GREENING MONETARY POLICY
A more subtle way to curb carbon use would be for central banks to change collateral rules. ECB Executive Board member Benoit Coeure hinted at that last year when he said criteria will eventually reflect climate-change risks.

Dirk Schoenmaker from Erasmus University estimates that tweaking the rules could reduce carbon emissions in the ECB’s corporate and bank-bond portfolio by over 40 percent. It could also lower the cost of capital for low-emission companies and wouldn’t interfere with how policy filters through to the real economy.

FINANCE AND CLIMATE CHANGE: WHAT ROLE FOR CENTRAL BANKS AND FINANCIAL REGULATORS?
One concern is that focusing on climate change would give central banks an excessively wide range of responsibilities, according to researchers including Emanuele Campiglio and Yannis Dafermos. That could be to the detriment of their primary goals of maintaining monetary and financial stability — a point also made in a United Nations report on enhancing green finance.

Giving too much power to unelected officials to set the agenda on such a sensitive topic could draw them into the political fray in a way that harms their independence. It also runs the risk of leaving them exposed to lobbying by special-interest groups.

That’s probably why central banks in developed economies are taking a market-neutral approach in their policies, while those in emerging markets — where mandates are broader and ties to the government more visible — have a broader variety of tools to address financial risks related to climate change.

In Lebanon, the amount of reserves a private bank needs to keep at the central bank depends on how much it lends to renewable energy ventures. In Brazil, policy makers demand lenders disclose how they factor in environmental risks into calculating capital needs. And in Bangladesh, banks can expect preferential terms when they borrow from the central bank if they pass on the money as green loans.



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