Should the World’s Central Banks Think Green?

SMITH BRAIN TRUST – Of the many potential impacts that climate change is likely to create, here’s one you might not have considered yet: Altering monetary policy.

But in various corners of the world, central bankers increasingly are paying attention to weather events, carbon emissions and environmentally driven finance efforts.

That’s because in much of the world, catastrophic weather events have been rising in frequency and, in some cases, in severity. And that has some monetary authorities contemplating whether such weather events should no longer be dismissed as temporary economic impacts, and instead spark a rethink of central bank mandates.

Maryland Smith’s David Kass keeps a close eye on global central banks. He says he understands the mental shift made by monetary authorities in some parts of the world, but doesn’t expect the U.S. Federal Reserve to contemplate altering its mandate any time soon.

“It’s a political issue,” says Kass, a clinical professor of finance at the University of Maryland’s Robert H. Smith School of Business. “The Federal Reserve maintains the credibility it has by remaining independent, and by maintaining its focus on its dual mandate of promoting maximum employment and price stability.”

That doesn’t mean the Fed is ignoring the climate science either. In November, the Federal Reserve Bank of San Francisco will host a research conference specifically to discuss the economics of climate change. The San Francisco Fed, which earlier this year published a widely shared paper on climate-change-driven economic risks, has also put a call out for submissions for research on related topics, including for potential implications on monetary policy.

Why? Some policymakers believe climate change poses systemic risks to the banking system and to the overall economy, both in the United States and elsewhere.

In other parts of the world, central bankers have long been grappling with the potential risks posed by the climate crisis.

They’ve warned that disruptions caused by destructive weather events make the task of economic forecasting increasingly tricky. Some researchers, including from the Brookings Institution, have suggested that monetary authorities might consider dropping their inflation mandate in favor of a nominal income mandate, which might smooth out the economic disruptions, or temporary shocks, seen in the wake of a weather event.

For now, that’s unproven. And no other metrics have shown themselves to be as reliable in gauging the health of an economy than those embraced by the Fed’s dual mandate – maximum employment and price stability. “That mandate has functioned exceedingly well,” Kass says. He cautions that giving too wide a purview to the unelected Federal Reserve would dilute its essential function, and ultimately hinder its independence, injecting politics in an area that historically has been largely free of partisanship.

Elsewhere around the world, some are advocating for a push toward more investments in environmentally friendly technologies, suggesting that policymakers reduce instability by buying up massive amounts of green corporate bonds. Buying enough of these, they say, and committing to hold them might even slow global warming. Others, such as ECB board member Benoit Coeure, have suggested that central banks might shift their collateral rules to reflect climate change risks.

In some emerging economies, central banks have already established a broader range of tools to address the financial risks posed by climate change. In Lebanon, for example, private banks can reduce the amount of reserves they keep on hand by lending more to renewable energy firms.

Last year, many of the world’s most prominent monetary authorities created the Central Banks and Supervisors Network for Greening the Financial System, forging an agreement to share insights and to “contribute to the development of environment and climate risk management in the financial sector, and to mobilize mainstream finance to support the transition toward a sustainable economy.” They’re looking to gauge climate risk management in the financial sector.

The Federal Reserve is one of the only major central banks to not join the network.

The Fed’s mandate, Kass says, is “abundantly clear.” And while examining economic risks posed by weather events or any other major disruption falls well within its purview, setting policy that focuses on climate change, or offering economic incentives for companies that adopt green technologies, does not.

“That goes well beyond the Federal Reserve’s responsibilities,” says Kass.“That’s a job for the legislative branch or the executive branch.”