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What does green central banking look like?

Christine Lagarde wants to make tackling climate change a central tenet of her Presidency of the ECB. So, what exactly is green monetary policy?

Christine Lagarde wants to make tackling climate change a central tenet of her Presidency of the ECB. So, what exactly is green monetary policy?

John Redwood

in Features


The green divide across the Atlantic has just got bigger. In the US, all the talk is of faster growth based on more domestic oil and gas extraction, with cheap energy and feedstock for industry. In the EU all the talk is of accelerating progress to a low-carbon or no-carbon future.

The Federal Reserve has to fend off demands from the President for still lower interest rates and for some quantitative easing in the manner of the Europeans, arguing in traditional terms about the trade-off between growth and inflation which is embedded in their mandate.

The Fed’s Review of monetary policy has so far produced little other than a few general comments about the need for clearer communication of their intents. The Fed think they have now done enough by way of rate cuts and liquidity injection for the US economy to speed up a bit next year.

For the moment the markets are giving them the benefit of the doubt, whilst an impatient President who wants a growth rate above 3% continues to chide them. None of them talk much about climate change.

Letting Lagarde down?

The European Central Bank (ECB) is adjusting to a new leader who wishes to make tackling climate change a central tenet of her Presidency of the bank. So, how green can a central bank become? What does a green monetary policy look like?

The staff at the ECB have so far published one recent commentary arguing the case that more emphasis is needed on raising equity to pay for the green revolution, deflecting some of the heavy lifting away from the ECB and the loans the commercial banks are able to make under their guidance.

The new European Commission is talking about one trillion euro of additional green investment over the next decade, with an implied substantial increase in lending.

Households will need to borrow to buy electric cars and new heating systems. Businesses will need to borrow to finance new facilities and new stocks and work in progress in supplying the green equipment and products. Utility companies have to complete their move to generate much more power from renewables. Governments and the EU itself will need to borrow to finance their part in green investment programmes. Governments and the EU will probably extend their grants and subsidies to get more consumers engaged with the transition in methods of travel and heating.

Money flow

The Central Bank may wish to develop assessment of lending policies with a green screen of some kind. Companies advancing the decarbonisation policy may be treated more favourably for loans than companies thought to be furthering carbon-based solutions.

There might be guidance about the volume of lending to the green economy, with encouragement to banks to shift their own book in the preferred direction of travel. The ECB will probably work closely with the EU Commission, who are planning their own big green deal soon, on how EU money can be harnessed alongside bank lending to increase green investment. The European Investment Bank is being told to become a financier of the green revolution.

The Green Deal itself will need to have things to say about how electric cars can be made more attractive to buyers, how people can be helped or compensated for scrapping older diesels and petrol vehicles, and how industry will be assisted with the big change to its product range and factories. It will probably encompass grants and incentives for people to insulate their homes better, to switch away from coal and gas fired heating systems, to improve their control systems and tap into solar and ground heat through suitable renewable methods. It should encompass the whole question of energy policy and the continuing dependence of the EU on Russian gas.

Changes happening already

The evaluation of banks and trading companies in terms of how green they are is happening anyway in the market, with some investors now wishing to differentiate on green grounds. Official moves to require clearer and more extensive green reporting will reinforce these changes and give people a basis of information on which to make judgements. Green ratings of loans and of companies may well emerge. There will be companies that lose out from a fiercer system of carbon pricing.

All this will leave Christine Lagarde with the big unresolved question she raised in a recent speech. How can the Euro-area accelerate its growth rate?

She will hope that the green revolution will be one of the prime drivers, generating demand for new cars, heating systems and the rest. It is true that new ways of generating power, new types of vehicle and other carbon reducing products are creating demand and fuelling the need for investment. It is also the case that this year the transition in the car market has been a heavy net negative for the Euro-area economy.

The public has got the idea of not buying new diesels sooner than it has acquired the taste for buying new electric vehicles. There has been a fall in car sales, and expensive rejigging of factories and investment. There have been plenty of closures of capacity for vehicles that are no longer wanted. It just shows that getting the balance right is not going to be easy. We are still some way off peak oil in the world economy. The US intends to exploit that by pumping more cheaper hydrocarbons in the meantime. If the EU does impose a carbon tax on imports that will provoke more trade rows with the US.

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