Central banks, climate change, and firing an AK-47 underwater (wonkish)

Barry Eichengreen has written a piece for Project Syndicate on how central banks can help tackle climate change and inequality.

The standard argument is that central banks do not possess the tools to combat these issues, and even if they did, doing so would call their independence into question, undermining their ability to fight inflation. Barry disagrees. He argues central banks have a swathe of regulatory tools that could be deployed, and this fact creates a moral responsibility to act given the existential nature of these issues.

As I read it, Eichengreen’s climate change proposal does not go beyond what most central banks have already expressed willingness to do: create a strict and consistent framework for disclosing climate risk, and then use that information when assessing risk in the financial sector. For example, banks who hold lots of assets with climate risk might have higher capital requirements, the same as if they hold lots of junk bonds or dodgy mortgages. There is no mention of using the balance sheet, or differentiating between the collateral a central bank accepts (as I discussed the other day).

His deeper point, that there is no shortage of tools for central banks to tackle important policy issues, is an important one.

Central banks often claim they do no possess the appropriate tools for tackling inequality or climate change. Look, they’ll say, interest rate changes take years to filter through the economy, and besides, the effects are too broad; it’s like trying to hit a target 500 meters away, with a shotgun, underwater.

This is a bit disingenuous. The experience of the GFC and COVID-19 has shown that tools can be invented to fit our needs; swap lines, the paycheck protection program, the Main Street lending program, the multiple variations of quantitative easing. Central bankers may well be the only innovators in the world who do not post about their new creations on LinkedIn.

Even the boring old interest rate can be incredibly flexible, as Eric Lonergan’s proposal for dual (and discerning) interest rates shows.

The real problem is not so much a lack of tools, but the risk of becoming politicized (I’m going to write a whole post on politicization, because it is more nuanced than it first appears). That’s a legitimate concern, and one we should seriously discuss.

Economics is about optimization under conditions of scarcity, so any such discussion should be guided by the trade-offs associated with independence. What policy tools would be available were maintaining independence no longer a concern? What would the costs and benefits of any alternative arrangement be?

Please do read the whole thing.

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