An apparent gulf has opened up between central banks on either side of the Atlantic over their role in battling climate change.
Jay Powell, chair of the US Federal Reserve, said the guardians of the world’s currencies should “stick to our knitting and not wander off to pursue perceived social benefits that are not tightly linked to our statutory goals”.
“We are not, and will not be, a climate policymaker,” Powell told a conference organised by the Swedish central bank this week.
At the same event, Isabel Schnabel, a member of the six-person executive board of the European Central Bank, advocated greater action to address climate change. The German economist pledged to “ensure that all of the ECB’s policies are aligned with the objectives of the Paris Agreement to limit global warming to well below 2C”.
The stark difference in approaches raises questions over whether monetary policymakers should lead the fight against global warming or play a much less active role.
Are environmental issues behind diverging attitudes to inflation control?
No. It is important to look past the huge rhetorical divide and concentrate on what they are saying about inflation.
The ECB’s position is clear, if a little convoluted. It worries that high interest rates to control inflation will undermine the green transition by raising the cost of investing in wind, solar, hydrogen and other clean energies necessary for moving to a net zero carbon world.
But Schnabel was clear that this concern was subordinate to the ECB’s mission to control inflation. While she recognised a “dilemma” about the damage high rates pose to green investment, the answer was to control inflation so borrowing costs could come back down.
“By bringing inflation down in a timely manner, monetary policy restores the conditions that are necessary for the green transition to thrive,” she told the conference, demonstrating the ECB’s settled stance on monetary policy after raising rates rapidly to 2 per cent in recent months.
The Fed’s governors do not have a similar dilemma to resolve, so the US policy is simpler. “Restoring price stability when inflation is high can require measures that are not popular in the short term as we raise rates to slow the economy,” Powell said, adding that the Fed’s independence allowed it to take the necessary measures on rates.
Where else are Fed and ECB policy fundamentally aligned?
They are aligned on two other important issues. First, that the primary role for green intervention lies not with independent central banks but with governments. Powell said that “in a well-functioning democracy, important public policy decisions should be made, in almost all cases, by the elected branches of government”. Schnabel concurred, saying, “governments must remain in the lead in accelerating the green transition”.
Second, they agree central banks have a role when supervising the banking system in ensuring commercial banks understand and manage financial risks from global warming. These include weather-related risks to infrastructure that banks have financed or fossil fuel assets that might become near-worthless in future.
This is a “narrow, but important” responsibility, according to Powell. ECB president Christine Lagarde pledged in 2021 to “ensure that every bank is making swift progress in embedding climate risks into their organisations”.
And where do their policies differ?
The most significant divergence is in how much they want to talk about their role in addressing climate change.
In sticking to its “knitting”, the Fed does not want to make any waves on the subject, while the ECB has made a commitment to analyse, advise and act to reduce carbon emissions. Addressing climate change was an important outcome of its 2021 strategy review, where it made a commitment to further incorporate environmental concerns into its monetary policy framework.
Concrete action is more limited, but the ECB has begun to tilt its portfolio of corporate bonds towards companies with better climate scores, something Schnabel committed to extending this week. The ECB is also looking at setting tougher environmental conditions if banks want to use bonds as collateral in the central bank’s financing operations.
The Fed does not have a corporate bond portfolio, having unwound its coronavirus programme in 2021, and has no plans to “green” its collateral framework.
Why do these differences persist?
The Fed has a tightly defined mandate of seeking “maximum employment and price stability”, while the ECB has a wider remit, which says it should also support the eurozone’s economic policies so long as price and financial stability are maintained. These policies include a green transition, so ECB rate-setters have concluded they have a responsibility to take some action against climate change.
The differences, though small compared with the rhetorical gulf, relate to different political pressures. The Fed must demonstrate it is not straying from its clearly circumscribed freedom to act on inflation and employment; the ECB faces pressure to do more to aid the transition — so long as it does not lose control of inflation.
Nick Robins, professor at the London School of Economics, said all central banks now recognised climate change’s “material risks” to financial systems. “Where they diverge depends very much on the differing mandates they are given by legislators and the political environment they operate in — and these differences were on display this week.”
But the ECB’s looser interpretation of its remit comes with risks. Paul Tucker, former deputy governor of the Bank of England, said green policies could backfire on unelected European central bankers if they became controversial.
“Although climate change is vitally important, Powell is right that independent central banks cannot decently make discretionary choices in this area in order to, as it were, tax polluters,” Tucker said, warning that “elected governments could impose legal constraints on the assets that central banks can buy or lend against”.
