Day two of the ECB Forum on Central Banking revolves around the theme of structural change and the implications of climate change for monetary policy. Follow the climate-related news and commentary from the conference as it happens below.
The programme includes sessions on climate and monetary policies in the euro area, and on productivity and business dynamics during economic shocks. The day concludes with a panel discussion in which ECB president Christine Lagarde will be joined by Bank of England governor Andrew Bailey, Bank of Japan governor Haruhiko Kuroda, and Federal Reserve chair Jerome Powell.
All papers and detailed conference proceedings are available on the ECB’s website and climate-related commentary from civil society organisations on the ECB’s recent strategy review has been published by Positive Money and the Council on Economic Policies.
Productivity, business dynamics and economic shocks
The effects on productivity and business dynamics during economic shocks was the first topic of the day. Discussion centred around a paper from Chiara Criscuolo, head of the productivity innovation and entrepreneurship division at the Organisation for Economic Co-operation and Development (OECD) which examines how Covid-19 has affected productivity and business dynamics in euro area countries.
The study identified four channels through which the pandemic destruction affected business activities: cross-sectoral reallocation; creative destruction and within-sector reallocation; adoption of digital technologies; and teleworking. The results show that sectoral reallocation is sizeable and moving towards high-productivity sectors.
In her presentation, Criscuolo focused on structural policy, calling it “a strategic ally to monetary and fiscal policies for a green, digital and inclusive recovery”. Her recommendations included policies to encourage digital diffusion and sectoral reallocation, and to encourage innovative firms (including those offering low or zero-carbon solutions).
John Van Reenen, professor at the London School of Economics, responded with his own presentation reviewing Criscuolo’s paper in detail. While agreeing with much of it, Van Reenen differed in his own conclusions. The effect of the pandemic on productivity depends on whether it will change policy making, he said. “The challenges we face in the OECD are tremendous,” he emphasised, pointing to slow pre-crisis productivity growth and the urgent imperative for a net-zero climate transition.
The core requirement is for ambitious thinking, Van Reenen concluded, calling for “a new Marshall Plan” based around rigorous evidence, innovation and the diffusion of best practice.
Climate change and monetary policy
The first session to focus directly on climate change was chaired by Frank Elderson, ECB executive board member and co-chair of the Network for Greening the Financial System.
Monetary policy is at the core of central bank response to climate change, he said, emphasising several times that all work in this area would be based on facts and evidence. “To make real progress policymakers need to stand on the shoulders of giants,” Elderson said. “Those shoulders are to be largely found in the research community.”
The discussion then turned to carbon pricing, price stability and the implications for monetary policy in the euro area. Professor Warwick McKibbin (Australian National University) was joined by colleagues Beatrice Weder di Mauro and Maximilian Konradt (Geneva Graduate Institute) to present their paper on climate change and monetary policy in the euro area. The paper is essentially a monetary policy scenario analysis under different climate policy scenarios.
The study examines the historical effects of carbon taxes on inflation in euro area countries to understand the impact of such taxes under the current European monetary regime. The authors then explore two alternative monetary policy situations simulated using a new version of the G-Cubed multisector model. They also examine the economic and inflationary impacts of physical climate change shocks and transition risks arising from carbon taxation within Europe and globally.
The results show that the inflationary effects of carbon taxes in euro area countries were only significant in the first two years. After that, the impact of carbon taxes on core inflation tended to be negative. The study also demonstrates that consumer prices increased less than producer prices, indicating that producers have absorbed a part of the carbon tax.
McKibben found that climate shocks all had a negative long term effect on GDP and reduced real European exchange rates in the scenarios examined. Climate shocks also permanently lowered real interest rates in the model outcomes.
Anna Breman, deputy governor of the Sveriges Riksbank, then reviewed McKibbin’s paper and spoke about climate and monetary policy. She began by quoting the physical science findings of the IPCC, highlighting the many ways in which the accelerating climate crisis will affect human society and the economy.
Calling for a global carbon pricing, Breman was clear that climate policies should and must change relative prices, but do not have to change overall price levels. Breman also called for further research using models to include large scale asset purchases, targeted lending, collateral policies and the interaction between physical and transition climate risks.
“As a policy maker, we are already facing a near future where multiple shocks are likely to impact inflation at the same time, and this is particularly the case with climate change,” she said.
In the past year and half there has been more inflationary volatility than in the previous six years, and climate change is a similar threat to price stability. However, it is important to distinguish transitory inflation – like that from the pandemic disruption or from carbon tax – from core inflation and longer term price trends.
Although McKibben’s study did not include a net-zero scenario, during the Q&A he explained that getting to net zero isn’t difficult. However that would require a coordinated combination of fiscal, monetary and emissions policies that so far does not exist.
Elderson concluded the session by listing his key takeaways: climate is a hot topic, and is a threat to price stability. He also stressed that central banks should not be on the side of those who slow down the transition towards a zero-carbon economy.
He ended by expressing his conviction that climate change is “at the core, at the very heart, of central banking”.
Monetary policy, employment and inequality
While redistributive fiscal policy is a governmental matter, it has a major effect on monetary policy. That was the theme of the afternoon’s third session, chaired by ECB executive board member Philip Lane.
“When we take monetary policy actions, regardless of their effect on inflation or employment, these actions may have an effect on inequality,” Lane said. “For transparency and accountability we should be clear about those side-effects.”
Inequality may also matter for other reasons, he said. “We think inequality of income and of wealth may play a role in the underlying equilibrium real interest rate.”
Lane then introduced three academics working at the intersection of macro-economics and labour economics, beginning with Professor Juan J Dolado of the Universidad Carlos III de Madrid.
Dolado gave a brief presentation focusing on the impact of expansionary monetary shocks and their transmission through different channels to affect inequality. Joined by Antonella Trigari (Bocconi University) and Gianluca Violante (Princeton University), the discussion was a technical and highly quantified discussion on how fiscal and monetary policy interact to affect inequality.
Transitory inflation trumps climate change in closing panel
The forum ended with a high-level panel discussion featuring the governors of four of the world’s largest central banks – the ECB’s Christine Lagarde, Bank of England’s Andrew Bailey, Bank of Japan’s Haruhiko Kuroda and Federal Reserve chair Jerome Powell. They spoke on issues arising from the conference, moderated by Reuters editor-in-chief Alessandra Galloni.
Galloni contrasted the “dark days” central banks were facing at last year’s ECB forum with the ongoing public health and economic recovery, before asking panelists to give their analysis and near-term predictions for the ongoing recovery from the pandemic.
Kuroda began, saying that while the Japanese economy is recovering, demand is still weak. He expects GDP to rise to pre-pandemic levels by early next year at the latest and thinks that consumption will recover in the coming months. He predicted a 4% growth rate for Japan in 2022.
Lagarde began with a mixed metaphor. “We’re back from the brink, but not yet completely out of the woods,” she said, predicting that, like the pandemic itself, the recovery will be unusual and rapid. However she warned that supply bottlenecks, energy prices and the possibility of a new Covid-19 variant are all major uncertainties.
Bailey listed the attenuation of the economic effects of Covid-19 and the economic effects of the vaccine roll-out as policy successes, speaking briefly about changes in labour patterns despite poor audio quality.
Powell agreed with Lagarde on the nature of the economic recovery. “This expansion is quite unusual and very different from the normal pattern,” he said. Demand is strong, Powell continued, blaming supply-side constraints for holding back the economy. The resulting inflation will fall as bottlenecks and supply chain problems are resolved, but this could take until next year.
Galloni then suggested that the current “transitory” inflation might be “stickier” than predicted, asking if “central banks should start acknowledging that they have let the inflationary genie out of the bottle”. Powell’s answer was “it depends”, blaming price rises on supply chain problems that can be resolved quite quickly. He also spoke about inflation expectations, saying monitoring of inflation expectations by the Fed shows no evidence of it.
Asked about the “upside risks” of inflation, Lagarde said that recent price rises are a result of the economy reopening. The ECB also sees little evidence of rising inflation expectations, or labour negotiations towards unusual wage rises.
Turning to Bailey, Galloni asked what was happening in the UK in terms of petrol queues and empty supermarket shelves. Bailey blamed supply chain disruptions for the problems, saying many factors are involved. Generally positive, he emphasised that “monetary policy can’t solve supply-side shocks”.
“Monetary policy can’t produce computer chips, can’t produce wind, can’t produce truck drivers,” he said. “What we have to do is focus on the potential second round effects from those shortages.”
Asked about the possibility of raising rates while quantitative easing is underway, Bailey said the primary tool of central banks remains interest rates, and that the BoE’s QE will naturally taper. Asked specifically about Brexit as a reason for the UK’s shortage, he pointed to shipping issues as a particular contributor as a result of Brexit.
In a quickfire round, Galloni asked each of the central bank governors for their list of the biggest risks to financial stability.
Climate change was at the top of Lagarde’s mind, and she warned that inaction on climate was a huge risk in itself. “If we are to completely ignore the consequences of climate change on the work that we do, on the assets that are held and on the transition that we plan going forward… I think that’s a risk to financial stability,” she said. There are many “traditional” risks, she added, but climate change is different and is a risk that “really needs to be prepared for”.
Powell was next. Cyber-attacks on large financial institutions, structural flaws revealed during the pandemic, and climate change were his list of threats to financial stability. “In the longer term I would agree that both physical and transition risks for financial institutions are a risk to financial stability.”
Galloni referred to a point made in an earlier presentation, that incorporating climate effects into inflation forecasts may make them more accurate. Asked for his views, Powell was sceptical. “What people didn’t see coming was the supply-side constraints,” he said. “I wouldn’t say that climate change is a particularly important aspect of the inflation forecasting story for 2021,” adding that it was “quite an interesting hypothesis”.
Still on risks to financial stability, Bailey identified cyber-attacks and the stress seen in core financial markets during the pandemic.
But Galloni doubled down in another lightning round. “What keeps you awake at night?” she asked each governor. “The recovery and weak consumption,” said Kuroda. Powell said tension between the Fed’s two objectives of maximum employment and price stability was his biggest challenge.
Bailey’s answer was to get through the UK’s supply-side issues, but he also mentioned climate change. Asked about his expectations for the upcoming COP26, Bailey said it will “cement the very real progress on what we’ve all been working at”, and pointed to “much tougher” disclosure and monitoring. Bailey also said disclosure will help to illustrate the “macroeconomic path” that to be followed during the carbon transition.
“Climate is by definition the ultimate global issue,” Bailey said, calling for support for all parts of the world.
The session ended with Lagarde calling for humanity and common sense in making sure everybody is vaccinated.
Overall, this year’s central banking forum was a disappointment on climate change, with no major announcements or progress on policy issues. The lack of time spent discussing climate change in the concluding panel was also revealing. Short-term issues surrounding the recovery from Covid-19 and near-term inflation took attention away from the longer term issue of climate change and a potentially existential threat to financial stability.
Unlike the Fed’s recent Jackson Hole conference, climate change was far from absent from the proceedings of the past few days. However, the urgency of transitory inflation clearly far outweighed the importance of the climate emergency.
This page was last updated September 29, 2021
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