For climate: Fed to divorce from market?
26 Jan 2023
"Beyond market neutrality? Central banks and the problem of climate change". This is the topic Prof. Matthias Thiemann1 approached at the latest "Futures of Sustainability"2 lecture at University of Hamburg. About the shift from market neutrality to market efficiency.
Why are central banks interesting? Because they are exactly situated between state and private economy. They are in the monetary system as well as in the political system. In the first they can restart the system by generating central bank liquidity, in the second they rely on private financial actors to enact policies. They are the carriers of state-economy boundaries. The question is: What can the state do and what can the state not do? For example when it comes to climate change.
With a keystroke the central bank can produce the money for a renewable energy transformation. And yet, that would completely breach a certain state-economy boundary. If it's so crucial to do the investment in renewable energy transformation, why are we not doing it as a state?
Central banks moved history. They moved with the problems. After World War 2 the central bank of France became a development agent: guiding credit and influencing capital allocation processes. Today, central banks don't lead sustainable development, they lead capitalism. As price stabilizators they are the central agent that keep the whole machine running.
However, things are changing. In the face of an imminent collapse of the earth system the possible path of sustainability hardly leaves any other options than to drastically control all social and economic activities. State and economy ally to control ecological crisis and catastrophes as effectively as possible. What are central banks up next to? Adapt all policies to the environmental emergency even though it may mean a suspension of democratic principles?
How did the problem of climate change enter central banks?
Through political pressure. The G203 were concerned that climate change could pose a financial stability risk that could turn into a systemic crisis. So they pushed central banks to address climate change, for example through the Financial Stability Board (FSB)4. The FSB is "coordinating internationally the work to address climate-related financial risks"5.
This surprising engagement of central banks with climate change then became a surprising radicalization. In 2017, the Fed was discussing divestment of objectionable assets6. In 2020, the Federal Reserve Board announced that it has formally joined the Network of Central Banks and Supervisors for Greening the Financial System, or NGFS, as a member.7 In 2022, the Fed nearly got a new board member, that had "written on the powers the Federal Reserve has to stimulate the transition to a clean, green economy"8 - Sarah Bloom Raskin. Only after a campaign of the oil and gas industry against her, she withdraw her nomination.
The open future of modernity vs the closing future of climate change
Modernity in contrast to the prior historical period is characterized by a perception of an open future. World views, which project the future onto the last judgement day are replaced by an open horizon, a future which cannot be known. This future can be shaped by human agency, placing men in the center of history.
How to process such an open future? The liberal and neoliberal answer is: through the open market. The market speaking the truth, guiding government practice opposed to a limiting and overboarding state. In an optimal market, prices speak the truth.
However: climate change is an issue that threatens to foreclose that future. We think we know how much CO2 we can still emit before we reach critical tipping points. Whereas the future was open in the modernity now we are almost bare to judgement day. The future is no longer uncertain. This means, the most important justification for the market as a tool for government breaks away.
Economic practices need to change. Imagine this: The "layers of an onion, with each layer peeled off over time leading to a further problematization of what it means to ‘be’ a central bank for central bankers in the context of climate change."9
The project is to "cultivate markets" to deliver on climate change. A difficult task due to time pressure (climate crisis) and perceived insufficient delivery by markets.
From "market neutrality" to "market efficiency"
In todays market, oil producers are perceived as the bad guys. Buying up their stuff means supporting something that is not working. Central banks should instead increasingly invest money green. But can they? Is that justifiable? Or are they overstepping their mandate? The European Central Bank (ECB) "shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources."10 The keyword here is "efficient". If the market misprices the risks associated with climate change, adhering to the market neutrality principle may instead support a market structure that hampers an efficient allocation of resources. A divorce of the ECB and the market is inevitable. In view of market failures, it seems appropriate to replace the market neutrality principle by a market efficiency principle. Such a principle would explicitly recognise that a supposedly "neutral" market allocation may be suboptimal in the presence of externalities. For decades the market and the ECB were allies, but in a failing market, the central bank has to fix the market. And the Fed? The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."11 "Effectively". This word changes a lot. "The words "effective" and "efficient" both mean "capable of producing a result," but there is an important difference. "Effective" means "producing a result that is wanted". Efficient means "capable of producing desired results without wasting materials, time, or energy"."12 The Fed's mandate is not about conserving resources: Thus, there is no need for the Fed to divorce from the market for the climate.
Inflation stays the primary mandate (price stability). That doesn't necessarily hinder green investments. Higher interest rates do disadvantage the renewable energy transition, so we first have to fight inflation (otherwise, we will have to do later and it will be worse). But when will there be a phase with room for green targeted lending operations? Central banks can not sufficiently address climate change in their current format, if everything has to be subordinated to the primary mandate.
We are stuck in a moment where central banks can not really on their own address the issue of climate change how we need them to. Central bank action alone is a cul de sac. We need to make central banks subject of political will (again). We need a repositioning of central banks in the context of climate change.
That's what the green swan13 debate is about. How can central banks coordinate with other actors in society who address climate change? For decades we pushed central banks into independence. Where they are not supposed to take any orders from anybody. But now the question is: How can we do credit guidance?
Central banks remain wedded to independence and price stability. Their current institutional set-up prevents their full engagement with climate change.
The “Futures of Sustainability” lecture took place on 25.01.2023 at University of Hamburg. Speaker for this topic was Matthias Thiemann.