Dear all, as promised, here is the English (and slightly longer) version of my article published in Le Monde – Selin Ozyurt : une relance « verte pourrait apporter le soutien tant attendu à la croissance européenne » . I hope you enjoy reading it!
In a context of weak growth outlook and inflation, the European Central Bank (ECB) announced in September 2019 new monetary stimulus by cutting the policy interest rates further and relaunching the net asset purchase program. Christine Lagarde, President of the ECB since November 2019, also suggested at her first press conference that the institution would play a key role in fighting global warming. So what role could the ECB play in 2020, while the global economy is slowing down unexpectedly and the climate emergency requires prompt action?
In the aftermath of the 2008-2009 global financial crisis, the enlarged toolkit of central banks has certainly helped to combat the danger of deflation. Yet, the effectiveness of additional monetary stimulus becomes questionable when rates are already close to their lower bound. The potential negative effects of low (and negative) interest rates are being openly discussed now, ten years after their first implementation. So, why are the interest rates still low despite their negative side effects on the economy?
The primary cause of historically low interest rates would be excess savings, reflecting greater risk aversion after the crisis in 2008 and the ageing of the population. According to American economist Larry Summers, the slowdown in productivity and low population growth reduced the growth potential of our economies over the past decades (i.e. secular stagnation hypothesis).
This leads us to wonder why productivity has been so low in advanced countries since the crisis. Underinvestment in the face of financial deleveraging needs, by governments and also the private sector, would be the usual suspect to explain the weakness of productivity. Stanley Fisher (Blackrock 2019) points out that lack of investment in infrastructure, education, renewable energy and digital technologies would limit potential growth and prevent TFP from returning to pre-crisis levels. Surprisingly, almost half of business investment decisions in the European Union (EU) would be hampered by inadequate transport infrastructure and lack of access to digital infrastructure (Boone and Buti 2019).
Vicious circle between low interest rates and low productivity
Interestingly, low interest rates may not only be the symptom but also the cause of the productivity problem. Recent research (Bergeaud et al. 2019; Gopinath et al. 2017) find that with low interest rates, a large number of unproductive firms and projects became artificially “profitable”. Accordingly, only a large technology shock would trigger enough productivity gains to get our economies out of this negative spiral.
With impending environmental challenges, failing investment in advanced economies become even more problematic in the medium term. Briefly speaking, the consequences of climate change are likely to weigh more heavily on our economies in two essential ways:
1) Further slowdown in labour productivity with increasing average temperature.
2) The destruction of productive capacities due to natural disasters.
In short, reducing CO2 emissions in entire sectors such as energy, industry and transport will require more and, above all, different investments.
“Explosive Cocktail”
Facing the “explosive cocktail” of economic and environmental challenges, a judicious combination of fiscal, monetary and structural policies (“policy mix”) becomes necessary. As Mario Draghi reiterated several times, there is significant fiscal space for stimulus in some euro area countries (e.g. Germany, the Netherlands, Austria). More generally, the positive differential between the real interest and economic growth rates offer a unique window of opportunity for fiscal accommodation, while preserving public debt sustainability.
One could also speak of a “green policy mix” in the light of recent announcements by European decision-makers. The new European Commission has presented its “Green Deal“, a green pact to achieve carbon neutrality by 2050. Yet, given the massive size of the challenge, the Green Deal should mobilise substantial budgetary, both at the EU and Member States levels.
Regarding monetary policy, Christine Lagarde stressed that climate objectives should be integrated into the ECB’s strategic review. Importantly, supporting the EU’s economic policies is part of the ECB’s mandate, as long as this does not undermine the primary objective of price stability. Thus, the ECB could already ally with the new Commission, in particular by ensuring that green projects benefit from favourable financing conditions. Although green securities have already been purchased under the ECB’s asset purchase policies (CPSP and PSPP), their volume remains very limited for the time being.
Greening the ECB’s balance sheet
As part of the “green policy mix”, Greens Bonds could become the central financing instrument for green projects and the European Investment Bank, the real financial arm of the Green Deal. The European market for Green Bonds is still in its infancy at the moment. Hence, the EU could increase the depth of this market by feeding it directly, but also through regular and large scale emissions from member states. A deeper secondary market for green bonds would allow the ECB to purchase larger amounts of green bonds and thus lower their yields, while respecting the imperative of market “neutrality”. Moreover, these purchases of green bonds will gradually make the balance sheet of the ECB greener, which is currently far from being CO2 neutral.
Finally, to ensure its effectiveness, the duration of this expansionary policy should be announced as soon as it is introduced, In addition, it is essential that the private sector takes over to play a central role in the energy transition of our economies takes over in the medium. This greening, through the investments in infrastructure and innovation it induces, could meet the technological challenge and stimulate productivity gains. Put differently, this “green” cooperation could ultimately get our economies out of secular stagnation and provide much-needed support to growth.