Central Banks and Climate Change

This article was originally published (in German) by the Neue Zürcher Zeitung here (also available as a PDF here).

In the article «Do we need a green monetary policy? No, because central banks are not suitable as global climate saviours» (NZZ, 16.1.2020) NZZ Economics Editor Thomas Fuster explains his scepticism about the increasing importance that central banks attach to climate change. He fears that the inclusion of climate issues in monetary policy will put central banks on “slippery ground” for which they have neither legitimacy nor appropriate means. He also fears that by taking up this issue, they are compromising their independence. There are growing signs that the opposite is the case. Central banks that ignore climate change are coming under increasing pressure.

Integration of Climate Risks into Risk Analysis

A first step to counteract this pressure is the integration of climate risks into central banks’ risk analysis, that underpins the purchase of securities and their use as collateral in monetary policy operations. Most central banks use the ratings of external providers such as Fitch, Moody’s and Standard & Poor’s for this purpose. In 2018, the Central Banks and Supervisors Network for Greening the Financial System, which brings together more than 50 central banks and supervisory authorities, including the SNB, pointed out that climate risks are not adequately reflected in these ratings. The conclusion is clear: central banks must supplement their risk processes in order to close the gaps – which the NZZ also highlighted last April – in the analysis. This is neither a conflict of objectives nor an overburdening of their mandate, but a fiduciary duty.

Market Neutrality is a Myth

The notion that this would violate an alleged principle of market neutrality, also quoted by Thomas Fuster, is a myth. Central banks are not market neutral. For good reason, they limit their bond purchases to securities with high credit ratings. They make active decisions about the allocation of their balance sheet to different asset classes. The SNB buys shares, most other central banks do not.  The SNB also excludes banks and bank-like institutions from its share purchases. The thesis that all this should be “market neutral” and that taking climate risks into account goes too far, is treading on thin ice.

Ignoring Social Concerns Endangers Independence

Beyond this risk perspective, it is becoming increasingly clear that climate protection must also be considered as a sui generis objective. For Thomas Fuster, this approach poses the threat of potential conflicts of objectives with the mandate of price stability. However, dealing with conflicting goals is already part of the day-to-day business of central banks. Since the financial crisis at the latest, the mandate of most central banks also includes financial stability. The SNB is also mandated to take account of economic developments and is committed to complying with the national and international norms to which Switzerland is a signatory. These include the Paris Agreement and thus the requirement to reconcile financial flows with climate protection goals.

Central banks use different approaches to deal with conflicting objectives. The distinction between primary and secondary targets is a viable way of doing this. A non-viable approach is to completely ignore fundamental societal concerns. This applies not least to climate change. Ignoring this core priority will endanger the independence of central banks.