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.

An AK-47 – close enough

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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Does carbon pricing work in practice?

Not according to a new meta-analysis out from Jessica Green in Environmental Research:

Carbon pricing has been hailed as an essential component of any sensible climate policy. Internalize the externalities, the logic goes, and polluters will change their behavior. The theory is elegant, but has carbon pricing worked in practice? Despite a voluminous literature on the topic, there are surprisingly few works that conduct an ex-post analysis, examining how carbon pricing has actually performed. This paper provides a meta-review of ex-post quantitative evaluations of carbon pricing policies around the world since 1990. Four findings stand out. First, though carbon pricing has dominated many political discussions of climate change, only 37 studies assess the actual effects of the policy on emissions reductions, and the vast majority of these are focused on Europe. Second, the majority of studies suggest that the aggregate reductions from carbon pricing on emissions are limited – generally between 0% and 2% per year. However, there is considerable variation across sectors. Third, in general, carbon taxes perform better than emissions trading schemes (ETSs). Finally, studies of the EU-ETS, the oldest emissions trading scheme, indicate limited average annual reductions – ranging from 0% to 1.5% per annum. For comparison, the IPCC states that emissions must fall by 45% below 2010 levels by 2030 in order to limit warming to 1.5 degrees Celsius – the goal set by the Paris Agreement (IPCC 2018). Overall, the evidence indicates that carbon pricing has a limited impact on emissions.

The ECB’s December meeting – climate change and fiscal policy

The ECB’s Governing Council met yesterday for their monetary policy meeting. Its a similar story to what we have seen from other central banks in recent months: expansion of monetary stimulus and a verbal commitment that stimulus will stay in place for at least another two years.

Some technical decisions to take note of (skip to the next section if your eyes are going to glaze over at the mention of the PEPP, APP, and TLTRO III)

  • They are increasing the potential size of their Covid-19 quantitative easing program – The Pandemic Emergency Purchase Programme (PEPP) – by 500 billion, to 1.85 trillion. Importantly, they will continue to reinvest the principals from maturing securities until the end of 2023no attempt to reduce balance sheets until then. Put simply, as the bonds they hold mature, and the principal is returned, they will reinvest it in new bonds.

    The ECB’s other QE program – the Asset Purchase Programme (APP) – will continue at its 20 billion/month rhythm, with the principals also reinvested.

    On the question of winding down QE, Lagarde has said that interest rates will be raised (they are currently negative) before the balance sheet starts to be wound down.
APP refers to the ECB’s main QE programme – the Asset Purchase Programme
  • The ECB will improve the terms and conditions of its Targeted Long-Term Refinancing Operations (TLTRO III). The TLTRO programs have been around in various iterations since 2014. Their aim is to preserve the flow of credit by allowing bank to borrow from the ECB very cheaply – at negative rates in fact. Imagine the bank paying you for taking out a mortgage with them.

    To qualify for the special low interest rate, banks must meet two conditions. First they have to reach a certain lending threshold (quantity). Second, they must lend the money to non-financial corporations and households, although loans cannot be used for house purchases (quality). This is a very subtle form of credit direction policy

Some broader points from Lagarde’s press conference:

Fiscal policy and central banks

Lagarde reiterates her call for expansionary fiscal policy. Take note of the phrase “medium term.” That could be anywhere from 2-10 years. Its a big shift for a bank that was a driving force for austerity 8 years ago.

Climate policy and central banks

Lagarde has called out how important it is for fiscal stimulus and structural reform to focus on the green transition. Its only words, but it reflects how much the ECB under Lagarde has shifted on this topic. It’s hard to imagine the Fed or the RBA openly encouraging green spending.

More interesting is the question of the ECB’s QE program and the green transition. Central bank bond buying has never applied any ‘green’ criteria, they have bought trillions in corporate bonds/notes from polluters and non-polluters alike. Since polluters are often a larger part of the market, central bank asset purchases have often benefited polluting industries. There have been calls for some time now for central banks to incorporate green criteria into their bond purchase programmes, or even penalise the use of “brown assets” as collateral.

To date these proposals have been fiercely resisted, on the grounds it would make central banks too political. However, cracks are emerging within the normally monolithic central banking community. Lagarde has come out and said she thinks climate change has price stability implications. If accepted, this would allow central banks to justify action within their existing mandates. She also hinted that the ECB’s asset portfolio needs to be examined from a green perspective:

In addition, from Jan the ECB will be making slight changes to its bond buying criteria to allow certain ESG (Environmental, Social, Governance) bonds to qualify:

While the arguments of those who favor keeping monetary policy narrowly focused do have some merit, it is time we began to openly debate them. They rely on the pre-crisis hope that monetary policy could be a neutral force and conveniently ignore all the political decisions made since the crisis.

If governance arrangements developed in the 1970s mean central banks can no longer deliver what is required of them by society, let’s re-examine the former, not under-deliver on the latter.

The pivot from denial to resilience is underway

The Royal Commission into Australia’s 2019/20 bushfires handed down its report last week. With the US election (sort of) over, I wanted to revisit it to talk about an omission I noticed at the press conference: climate change.

Minister David Littleproud introduced the report saying:

The real theme about the report is around risk reduction, preparedness, around response, relief, recovery, reconstruction and above all, resilience.

The report mentions climate change 67 times. Minister David Littleproud mentioned it zero times. When asked a question about the relationship between natural disasters and climate change – a point the report raised repeatedly – he fluffed about the government’s (panned) 2030 emissions target before talking about how technology like carbon capture will solve global warming for us. No one is denying technology matters, but carbon capture is still in its early stages and is no a silver bullet.

This is part of the slow motion evolution of conservative environmental politics. ‘Resilience’ is central to their emerging position on climate change: from outright denial to grudging acceptance and a focus on ‘resilience’ and ‘adaption.’ I imagine eventually we will reach a point where they accept climate change but argue it is too late (or too expensive) to do anything except build resilience and adapt, aka not much.

This is happening alongside the shift to ‘rivers, forests, and reefs.’ Clean rivers, well-managed forests, and wildlife are all vitally important, but are often a useful rhetorical advice to shift attention from climate change; a way to talk up green credentials without doing anything meaningful. As climate change damages these habitats and causes natural disasters, it may perversely allow governments to draw attention away from the big abstract global problems to nitty gritty issues like how many fire-fighting planes we need. Its much simpler to fight fires than do something about climate change.

A third vein which I have yet to see, but expect soon, will be the fusion of ‘rivers, forests, and reefs’ and anti-immigration politics. Our pristine countryside and fragile ecosystems will join our jobs and ‘way of life’ as the things at risk from swarms of immigrants. We tend to think about the environment as a progressive issue, but it absolutely need not be, nor has it always been historically.

What can progressives do? Overly apocalyptic assessments might play straight into conservative hands, allowing them to pivot completely to ‘resilience.’ We need to keep the link between natural disaster and climate change before people’s eyes, while proposing real solutions that give people hope. My vote still lies with Green New Deal style policies.

Wollemi and rewilding

I was in the Wollemi national park a few evenings ago. Our campsite was by a river in a large clearing. Ringed by large rock formations, there was no exaggeration in the National Park website’s description: “Mother Nature’s amphitheater.”

An unexpected treat lay down river. Two winding kilometers away are the Newnes Industrial Ruins. For about 30 years between 1900 and 1930, oil-rich shale was mined, processed, and piped away. The ruins emerge out of the bush quite suddenly and there is something forlorn about the way they cling on to the landscape. Today the columns are long gone, the distillation trenches are caved in, and the railway tracks overgrown. The skeletons of human industry are still visible, but I was surprised by how much nature has reclaimed over the last 90 years; especially when you consider how violent and toxic shale mining would have been.

Newnes at its peak

It got me thinking about rewilding. I recently watched David Attenborough’s new documentary, A Life on our Planet, where, amongst other things, he calls for rewilding much of the natural world. Appropriately, the film starts and ends in Chernobyl, where the wild has quickly returned to the hastily abandoned exclusion zone. Newnes is a similarly hopeful reminder of nature’s resilience, although it should not inspire complacency; Newnes has been closed for 90 years, more time than we have, and nuclear disaster is an unreliable conservation strategy.

The obstacles to rewilding may come in unexpected forms. The biggest roadblock to rewilding the Scottish Highlands with woodland is deer, which eat the saplings. Ironically, the solution to date has been year-round culls; reintroducing bears or wolves has been a step too far, for now.


From a highly recommended piece in the FT on the souring of US-China relations (a point I have made elsewhere):

Two interesting takeaways. First, how rapidly public opinion on China has changed:

Opinion has historically been volatile, moving up or down by at least 10% in 2008-2011 and 2012-2016. These swings are rapid, which suggests to me that many voters have no fixed opinion on China. The optimistic take is that today’s deeply unfavourable views could change should the situation improve, and public opinion may not yet act as a constraint on political decision making. The longer tensions remain elevated, the greater the danger these views harden and eventually solidify into something akin to the instinctual distrust of Russia (there is a reason the proto-typical Hollywood villain is Russian).

This matters because of climate change. The foreign policy hawks on Biden’s team clearly see prize US national security intransigence over cooperating on climate change:

Optimistically, we are fast reaching the stage where it will be rational for individual states to pursue a green agenda independent of what the rest of the world does, especially now China has committed to net zero in 2060. It may also be possible for escalating national security tensions to go alongside national decarbonisation. They could become symbiotically linked, with each party racing for energy independence or leadership in green tech.

One of the accepted wisdoms of the last few decades has been that international cooperation is required to get important things done. Its corollary was that the nation-state was materially constrained by international forces beyond its control. These may be less and less true. It is a pressing question for us all and I will return to it again. For a riff on this question from the perspective of the EU, I recommend this debate between Streeck and Tooze in the LRB.