Market efficiency mandate requires climate action, say ECB figures

A group of leading European Central Bank (ECB) figures have said that “market imperfections” that incentivise continued greenhouse gas emissions result in an inefficient allocation of resources and therefore require correction under the ECB’s mandate. In contrast to the so-called market neutrality principle used to avoid targeted climate action, they call instead for an “efficiency principle” operationalised through the alignment of all central bank actions with the Paris Agreement.

“A central bank neglecting the climate implications of its policies may foster market imperfections,” wrote ECB executive board member Isabel Schnabel, financial research head Simone Manganelli, deputy director of general research Philipp Hartmann and three senior ECB economists. “This would create a dissonance with the European Treaty, according to which the ECB must act ‘in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources’.’.

Published by VoxEU policy portal of the Centre for Economic Policy Research, the article included the caveat that the views expressed are personal and not those of the ECB or the Eurosystem.

“It is not clear that political processes can achieve the ecologically and economically desirable carbon pricing,” the authors say, and so a much broader approach involving a multiplicity of parties will likely be necessary to mitigate the “market imperfections” that cause and support global heating and an eventual climate catastrophe. These flaws in market efficiency largely involve the failure to internalise the costs of climate change into the price of carbon, as well as informational frictions, including asymmetric information in which emissions data is limited or not publicly available.

Within their mandates, central banks can contribute to the fight against climate change through analysis, disclosure and data, and monetary and financial policies, they argue. In each of these areas central banks can act as thought leaders and work to improve the reflection of climate risks in asset markets and to reduce distorted economic incentives.

Specifically, the central banks can tilt asset purchase programmes towards bonds issued by greener firms, the authors suggest, using a “Paris-aligned benchmark” as a proxy for a “market efficiency benchmark”. They could also require that collateral pools be Paris-aligned, increasing the funding costs of high-carbon issuers and thus reflecting efficiency considerations over and above risk. Disciplining banks to adequately assess, manage, and disclose their climate-related exposures would not only create better data and more accurate risk pricing, they add, but would induce non-financial companies and households to also take those risks into account.

“Mitigating or even removing biases in asset portfolios, re-calibrating collateral policies, and enhancing prudential discipline over banks can help to avoid contributing to the market imperfections that hamper the socially desirable transition to a carbon-neutral economy,” the article concludes. “This resonates with the Treaty provision that in pursuing its primary and secondary objectives the ECB should favour an efficient allocation of resources.”