It is increasingly clear that a green transition cannot take place without greening the financial system too. This has thrown the focus onto the possibility of ‘net-zero central banking’ and what it might entail. While early signs are encouraging, there has so far been more rhetoric than concrete commitments. Will central banks take a narrow understanding of their net-zero mandates and focus merely on ‘greening’ their current interventions and portfolios? Or will they take a broader view that challenges monetary orthodoxy and positions themselves as architects of a new financial system, rather than mere custodians of the status quo?
A narrow understanding of ‘net-zero’ would involve central banks ensuring their collateral frameworks and asset purchases only ever hold the greenest assets. This would likely have further beneficial effects by driving up demand for these green assets – from renewables providers – and restraining demand for the so-called ‘brown’ assets issued by polluting companies. Potentially, this could unlock new streams of green private finance and such moves appear on the horizon, with both the ECB and Bank of England likely to act first.
Another change a narrow ‘net-zero’ could involve is incorporating climate considerations into to macro-prudential regulation. This would involve more carefully modelling how climate risks become macro-financial risks and adjusting policy accordingly. Or new regulations which include banks’ climate risk exposure when conducting stress-tests, as well as more cajoling moral suasion from central bankers. This in many ways has already arrived. Both Mark Carney, during his time as governor of the Bank of England, and his successor Andrew Bailey have warned of the macro-financial risks of climate change.
Both greening portfolios and modelling climate risk as financial risk involve central banks doing what they already do, just with climate in their mind as they do it. It is left to government to directly regulate polluters, and use fiscal policy to drive a green transition. In this narrow net-zero central banks are important, but more passive.
Yet the sums needed to ensure a green transition are vast. A Stanford University report estimates a global upfront investment cost of $73 trillion, making it the costliest endeavour in human history. It is why despite vocal commitment to decarbonising, no major economy has yet come up with a credible plan of how to fund it.
This is where a more expansive view of net-zero central banking could help. Since 2008, thanks to large scale asset-purchase of central banks which have seen the balance sheets of the major central banks expand to $24 trillion, costs of government borrowing have been kept mercifully low for the richest countries, with the UK managing to even sell bonds with a negative yield for the first time in 2020.
These asset purchases have been done under existing central bank mandates, with Bank officials always able to deflect accusations that this amounts to monetary financing and maintain that they are merely trying to hit their targets. Yet if states were to try and truly expand green financing to the levels required and inflation crept above target levels, what would happen?
Central banks stick to a narrow view, unwind asset purchase programmes, and raise interest rates. But high borrowing costs would make an already Herculean task for governments nigh on impossible.
It’s why a more activist notion of net-zero central banking must take hold. Central banks could commit to doing ‘whatever it takes’ to help fund the transition to a zero-carbon economy. They could explicitly in their mandates eradicate any worries about governments funding the transition through guaranteeing a price paid on government bonds. To avoid worries about outright monetary financing, perhaps this could be limited to green infrastructure bonds which would in turn cheapen the cost of this borrowing.
To coordinate in such a way would not necessarily be to abandon the principle of independence, after all central banks are constantly coordinating with government policy. That is how they fulfil their mandates. This would, however, be a different sort of coordination.
Coordination traditionally results in monetary and fiscal policy pulling against each other to create an equilibrium, whereas this would be both working in tandem to achieve the same goal. That would be bound to cause jitters, but as mentioned, taking the broader net-zero view results in more uncomfortable questions about monetary orthodoxies but also potentially more solutions to the climate crisis.
Moving into the sphere of regulation, would a central bank taking the broader view be far more punitive in how it granted access to its reserves? Would it not just green its own portfolio but punish those who invest in the worst polluting companies by raising their borrowing costs or cutting their access to reserves altogether? How much macro-financial stability would a central bank sacrifice in order to meet its climate commitments?
Such questions challenge the long dominant idea of monetary policy and central bankers as custodians first and foremost of the financial system. Regulation such as this would need to be coordinated with government and would thus throw up further questions about central bank independence as well as democratic decision-making. However, it would be a useful tool alongside regulation to allow the government to turn off the taps on certain industries.
Some may argue that the costs of adopting a broad definition of net-zero central banking are too great to consider. Yet, it is worth also considering the prospect that governments are currently fighting humanity’s greatest existential crisis with one arm tied behind their back. The climate crisis will challenge many orthodoxies, including those of monetary governance, whether central banks adopt the broad view or not.
Bryn De Ivey is a student on the Goldsmiths MA Global Political Economy. He is on twitter @BrynDeIvey