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Central Banks and Climate Change: Don’t miss the point

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European central bank frankfurt de
Photo European Central Bank by ProfessionalPhoto from Pixabay

Recent media coverage of the debate around central banks and their response to climate change has been positive to see.

However, some of it takes at face value the assertion that central banks are overstepping their remit by weakening their commitment to market neutrality. One interesting recent example was The Economist article, Green Envy: The rights and wrongs of central-bank greenery.

That article was cautious about the assertions by the new president of the European Central Bank (ECB), Mme Lagarde, that the bank has to explore climate change in all its dimensions. Arguably the ECB places a far greater emphasis on market neutrality than other Central Banks and it is right to question this emphasis. This is particularly so given the unique nature of the challenge climate change presents. The Bank of International Settlements (the Central Bank for Central Bankers) has itself recognised climate change represents an epistemological break. Conventional wisdom will be insufficient to address the upcoming crisis.

Central Banks have the remit of ensuring financial stability. However, it is increasingly accepted that stability will be impacted by climate change because of the feedback loop between the financial system and climate change. Central banks should bias capital away from big emitters of carbon to reduce the likelihood of severe climate-related impacts on the economy. By insisting on market neutrality in their own portfolios, but simultaneously pushing the financial institutions they regulate to divest risky assets, Central Banks are sending mixed messages. Mme Lagarde is quite rightly correcting this.

More broadly, it is not realistic to draw a clear line between the roles of Central Banks and politicians when it comes to climate change. Framing such measures by central banks as an alternative to a global carbon tax or other policy measures ignores the potential for complementarity between fiscal and monetary policy – a complementarity that will increase the sustainability of both finance and the wider economy.

Climate change represents new territory for Central Banks. Existing academic research is only just beginning to engage with the challenge posed to central banks and the banking system by climate change. This new territory requires taking a pragmatic rather than dogmatic response. As John Maynard Keynes might have said, "in the long-run we're all dead and we will be dead a lot quicker if we don't do something about climate change".