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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Is Green Quantitative Easing on the horizon?

Many forces are pushing central banks to change how they operate: low inflation; hesitant fiscal policy; climate change; anemic growth; financial instability. Low inflation claimed the first scalp, when it led the Federal Reserve to switch to an average inflation targeting regime. Climate change may be the next.

The FT reports that:

This is a big deal, even if it might sound like gibberish at first.

Right now, to stimulate the economy, central banks print money (it’s slightly more complicated) to buy government and corporate bonds from the private sector. The idea is that this lowers bond yields, which lowers interest rates, and moves money into other parts of the economy. In theory, interest rates for governments and corporations fall, and lending should increase to businesses and consumers, stimulating the economy. This is Quantitative Easing.

Today, central banks do this without taking the environment into account. A corporate bond from Shell is the same as a corporate bond Vestas (they make wind turbines). For several years now, people have been saying that central banks should use Quantitative Easing in an environmentally conscious way. This mean that, when it buys a corporate bond from Shell, it should acknowledge that Shell is a polluter. When it buys a corporate bond from Vestas, it should acknowledge that Vestas is not a polluter. It could do so by charging a premium for example.

This has been fiercely resisted to date. The fact that the head of the French central bank, who has a seat on the ECB’s Governing Council, is in favour, speaks to how much the consensus is changing.

Please do read the whole thing

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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.


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.

Carbon Taxes

Xi’s recent declaration that China would be carbon neutral by 2060 prompted me to read a few pieces on environmental politics I thought I would share.

Carbon taxes have been a central objective of the environment movement for many years. Success implementing them has been decidedly disappointing. Where they have not been outright rejected or rolled back, as in Australia, they operate in watered down forms.

The dial has been shifting slowly. US Republicans and major oil companies lined up in 2018 – along with over 400 economists – to advocate for a $40 carbon tax. Too good to be true? Yes. Alongside the tax, they also want to repeal the environmental legislation that allows the government to regulate carbon emitters and immunity from all future climate related lawsuits. You might be familiar with this image, from the famous ‘Big Tobacco’ trial? Big Oil would like to avoid the same. This NYT op-ed from 2018 is a nice overview of the politics.

Cancer? What cancer?

Carbon taxes are so universally supported by experts that they sometimes appear like miracle cures; simple market-based mechanisms that will gradually transition economies while stimulating research in green technology. This piece in the Boston Review dissects this hope to reveal a grimmer reality. The central problem today is that any politically viable price on carbon would be environmentally impotent.

Even when prices do exist, they are quite low. According to the World Bank, countries need policies between $40 to $80 per tonne to meet the Paris Agreement targets. Yet half of the world’s carbon prices are less than $10 per tonne, while only five countries—Sweden, Norway, Liechtenstein, Switzerland and France—are in the target range. Even the prices in these countries are probably too low.

New Zealand’s cap-and-trade system exempts agriculture, even though agriculture is responsible for over half of the nation’s emissions. Mexico has a small carbon tax on fossil fuel production that excludes fossil gas completely. And in the United States, 11 out of 12 states with any carbon price only apply it to the power sector.

They advocate a mix of “large-scale industrial policy,” legal attacks on the fossil fuel industry (similar to Big Tobacco), and government regulations and timelines for decarbonization to encourage private sector planning and investment.

It is a familiar policy mix, which to my mind is only a good thing. Market-based mechanisms like carbon taxes will be necessary but not sufficient to combat climate change and there is no stronger evidence than the fact that the companies who would be subject to them are getting on board.

Going it alone

Last week China announced that it would be carbon neutral by 2060. Meanwhile Australia continues to cement its position in the dustbin of history with an insistence on a “gas led recovery,” and a refusal to set a date for going carbon neutral. As the world’s largest emitter, China’s commitment is a ray of hope cutting through the depressing fog that is contemporary climate politics. Along with the EU, a large block is now committed to making a transition.

From Adam Tooze’s recent piece on the decision, this thought provoking passage:

The conceit that one can still hear from veterans of US climate diplomacy is that the world is waiting for America to come back to the table and that no big deal like that at Paris in 2015 is conceivable without the United States.

But 2020 is not 2015. The sobering truth is that neither the EU nor China is any longer conditioning its climate policy on the United States. If you are serious about the issue, how could you?

Please do read the rest.

We are in an odd historical moment where power is being disaggregated. Historically, power shifted evenly. Today, even as economic and now climate leadership incrementally shifts away from the United States, it maintains predominance in military and financial matters. I can picture this a recipe for disaster as equally as cooperation.