WASHINGTON, March 7 (Reuters Breakingviews) - Central banks don’t think they can do much about the environment. The European Central Bank has introduced some climate considerations into its bond portfolio, while cautioning that fighting global warming is for politicians, not monetary wonks. The U.S. Federal Reserve has done even less, arguing it should not tackle climate change without an explicit order from Congress.
Recent energy price shocks and natural disasters support the ECB’s approach – and suggest central banks could go even further. The Fed has the power and the tools to play a small but crucial role in easing the green transition.
Nearly every central bank’s primary goal is to keep inflation in check. Yet climate change has slowly wormed its way onto policymakers’ radars in recent years. Former Bank of England Governor Mark Carney warned about rising temperatures in a 2015 speech, predicting that financial systems would face steep losses if weather disasters intensified. The sentiment is shared by other central bankers. In a 2021 survey by Invesco, 63% of responding central banks said addressing climate change fell within their mandate.
Yet the Fed, the world’s most powerful rate setter, has largely shied away from the topic. Chair Jerome Powell said in January that the U.S. central bank “will not be a ‘climate policymaker.’” In a ranking of G20 countries by advocacy organization Green Central Banking, the Fed sits in the sixteenth spot.
Ignoring the effects of global warming doesn’t make economic sense. For starters, the United States’ reliance on fossil fuels leaves it vulnerable to inflationary spirals induced by energy shocks. Russia’s invasion of Ukraine drove natural gas and crude oil prices sharply higher throughout 2022 as supply fell substantially short of demand. Higher energy costs accounted for more than half of overall inflation in the euro zone. The U.S. is less reliant on imported fuels than Europe but was not immune from the rise in costs. Energy prices rose 9% in the year through January, according to the country’s Consumer Price Index. Shifting to domestically sourced renewable energy would protect the U.S. and other countries from such shortages and the price surges they cause.
Climate change also threatens to lift inflation and crimp growth through more frequent and damaging natural disasters. Extreme weather events cost the United States $165 billion in 2022, according to the National Centers for Environmental Information. That’s the third-highest total since 1980, and more than triple the historical average. As rising temperatures make such disasters increasingly common, spending on repairs and relief could disrupt economic activity and put upward pressure on prices.
Interest rates – central banks’ main tool for managing the economy – also have an impact on the cost of investments in renewable energy. A 2020 study by the International Energy Agency found that, when discount rates, which loosely track central bank interest rates, double, the cost of sourcing electricity from offshore wind turbines climbs nearly 45%, while the price of energy from a gas-fired power plant is largely unchanged.
The cost of reaching net-zero carbon emissions is already steep – it could reach roughly $275 trillion by 2050, according to a McKinsey analysis. Interest rate decisions by the Fed and other major central banks could have a meaningful impact on that figure.
Climate change also affects the labor market – another key area of focus for the Fed. Warmer weather has already cut working hours in sectors like farming and construction, according to a 2021 research paper by the Public Library of Science. Failure to slow global warming could wipe out some 900,000 U.S jobs every year over the next half-century, Deloitte said in a January 2022 study. The economic damage would also wipe nearly $70,000 from every working Americans’ lifetime earnings.
The Fed has ample reason to take action – and plenty of ways to do so. The ECB announced in February it would “more strongly” tilt its portfolio of corporate bonds toward companies that emit less and have better environmental disclosures. Doing so gives greener firms a slight edge when raising cash.
The Fed doesn’t currently hold any corporate debt, but it can get a head start on greening future purchases. Its European peer unveiled plans to make climate disclosures mandatory for companies’ bonds to remain eligible for purchase or to be used as collateral in refinancing. The U.S. central bank could follow that path and create a meaningful standard for climate transparency.
Fed officials have already told the largest U.S. banks to analyze how they’d be impacted by global warming, and Powell has promoted the effort as crucial to better understanding the risks climate change poses. Still, the analyses are limited in scope. The exercise only covers the six largest banks and tracks two green-transition scenarios: one based on current policies and one based on reaching net-zero emissions by 2050.
The Bank of England, meanwhile, conducted similar tests in 2021 that scrutinized the country’s 19 largest banks and insurers, and examined three scenarios. The more comprehensive assessments found that delayed government action on carbon pricing led to the greatest financial-sector risk.
Some central bankers, like Bank of France Governor François Villeroy de Galhau, have advocated for more ambitious policies, such as making it more expensive for high-polluting firms to raise capital. Yet such direct action would face too much political blowback in the U.S. The Fed places great value in its independence, and climate remains a hot-button political issue.
Even the Fed’s limited climate analyses for banks have caught flak from Republicans, with many demanding the Fed avoid any appearance of mission creep. Powell has rightly noted that Congress could change the Fed’s mandate to include climate factors, but unless conservatives change their mind, that’s highly unlikely.
Central banks aren’t best equipped to lead the green transition, anyway. Legislatures should take charge. Even Isabel Schnabel, the most climate-focused board member at the ECB, said in January that fiscal policy “needs to remain in the driving seat” as the world economy tries to go green.
There’s also a valid concern that focusing on climate change could water down the Fed’s mission to fight inflation. Central banks’ pivot on climate happened well before inflation surged to multi-decade highs. Soaring prices pose a greater near-term economic risk than global warming, as failure to cool inflation can erode demand and spark a deep recession. Price growth has eased somewhat from last year’s highs, but central banks are wary of focusing on anything else until inflation slows further.
Still, the Fed can take meaningful steps to protect the U.S. economy from climate change. Other central banks have already set the example and highlighted the clear risks global warming pose to inflation and employment. The Fed led the way in raising interest rates to fight pandemic-era inflation. On climate, it would do well to follow its peers.
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