Lagarde’s green push in monetary policy would be huge step
Last week’s gush of enthusiasm for green finance suggests European politicians might finally walk the walk on climate change.
The European Parliament has declared a climate emergency; the new European Commission has taken office on a promise of an imminent “green new deal”, and Commission president Ursula von der Leyen has vowed to accelerate emissions cuts. But the real game-changer could come from the European Central Bank.
Christine Lagarde, its new president, is pushing to include climate change considerations in a review the central bank is due to hold into the way it conducts its monetary policy. Until now, the expectation was for a review into purely monetary matters, such as whether the inflation target should be revised.
An explicit focus on climate change policy would be a huge move. Because the central bank is by far the biggest influence on financial conditions in the market, it can make a significant difference to the investment decisions that determine how Europe’s climate transition goes.
Ms Lagarde’s move is bold in a political sense too. She was already unlikely to have much of a honeymoon. Many of her colleagues on the ECB governing council laid down markers for future debates with their unprecedented public criticisms of the central bank’s latest package of monetary stimulus. The review is going to be a highly contested affair. Adding climate change policy to the mix — which Ms Lagarde has said she sees as “mission critical” — is probably going to inflame passions further.
Green finance experts are backing Ms Lagarde’s move. “More than good, it is a necessary idea”, says Daniela Gabor, professor of economics and microfinance at University of West England Bristol. Currently, “ECB monetary policies have an implicit carbon bias” because the rules for buying securities under its quantitative easing programmes “rely on traditional credit ratings where climate exposures are irrelevant, she says. “Financial markets misprice climate risks, and monetary policy operations reproduce this market failure,” she adds.
The commission, too, is looking into ways to channel private capital into green investments. It is considering easing capital requirements on banks insofar as they provide climate-friendly loans.
That has raised hackles among bank regulators, who fear that banks will be allowed to get away with excessive risk on the pretext of green investing. If a “green discount” on capital requirements really does change investment decisions, a less risky alternative might be to raise capital charges on “brown” or climate-unfriendly assets rather than lower them on green ones.
The devil is in the detail of how “green” investments are defined. Ms Gabor warns that “you need a credible taxonomy of green and brown assets . . . so that it avoids greenwashing” by defining “green” assets too broadly. “Without a penalty for brown assets to go hand in hand with preferential treatment of green, we have too much carrot and too little stick,” she says.
These questions will come up in the ECB’s strategy review if Ms Lagarde gets her way. Her detractors have already argued that an explicit focus on climate change lies outside the central bank’s mandate.
But here Ms Lagarde has expert support: In a submission to the European Parliament on Monday, University College Dublin economics professor Karl Whelan underlines that the mandate is much broader than is often understood. As long as price stability is secured, the ECB is obliged by treaty to “support the general economic policies” of the EU. That could warrant, for example, financing European Investment Bank bonds for climate investments at low interest rates.
“The new presidency is a good opportunity for some more radical change,” Mr Whelan told the Financial Times. “As a former politician, hopefully Lagarde will be less afraid to use her substantial mandate and powers to do more than just achieve impeccable price stability.”