Climate disruption is the major challenge of the 21st century, leading to profound transformations in our societies, territories, and economies. The economic and financial challenges linked to climate change and the transition to clean energy would require central bank action to a certain extent. However, it should not be forgotten that governments and multilateral development banks (MDBs), and organizations are better placed to lead and support the fight against climate change and ensure the low-carbon transition.
The strong demand for critical materials to the expansion of green technologies (copper, lithium, nickel) will certainly continue to drive prices up in the context of supply inelasticity. The implementation of a carbon tax on fossil fuels would set a price on carbon pollution and hence play a pivotal role in reducing GHG emissions and channeling investments into cleaner alternatives. Even if a well-designed carbon tax would have a relatively small impact on inflation in the long term, the materialization of climate risks in the short term could push central bankers to act to contain inflation, decrease price volatility, and anchor expectations.
In addition to their responsibility to ensure price stability, central banks are concerned about the impact of climate risks on financial stability and their integration into regulatory and supervisory frameworks. More frequent and severe natural disasters caused by climate change are likely to result in higher losses for insurance companies, trigger sharp declines in property prices, and potentially weigh on household and business solvency. The transition to non-fossil fuels could lead to stranded assets with a destabilizing effect. The rush for green investments and greenwashing could create green asset bubbles while increasing the risk of sudden price corrections. In both cases, the action of financial supervisors will be decisive in ensuring the resilience of the financial system. This means ensuring that financial institutions disclose their exposure to stranded assets, develop plans to manage these risks, and also set aside a sufficient capital buffer to absorb potential losses. Financial supervisors can also encourage financial institutions to invest in green assets and support the green transition.
Like any financial institution, central banks could choose to support the transition to a low-carbon economy by greening their operational framework for loans, collateral arrangements, and asset purchases. The European Central Bank and the Bank of England are pioneers in this area, having initiated the inclusion of climate-related policies in their operational frameworks.
However, before taking action on climate, central banks should carefully assess the risks and establish the limits to be respected. Central bank mandates generally exclude actions that target specific agents or directly finance governments. Adding the fight against climate change to their mandate risks endangering their independence, by exposing them to increased political pressure. Becoming responsible in an area where their capacity for action is limited risks damaging their credibility in pursuing their primary mandate.
To avoid giving in to inaction but also to limit the risks to central banks, the action of governments, multilateral organizations and MDBs with considerable financial resources and a broader policy toolkit (fiscal and regulatory) will be decisive in winning the struggle of the century.
I hope you enjoyed this article. For a deep-dive on climate finance, please check out our IFC-Amundi Emerging MArkets Green Bonds Report 2023