Climate crisis may have ‘substantial’ effects on natural rate

Global heating and the natural interest rate, further calls for an RBA climate mandate, how the green transition may reduce inflation and more from this week in green central banking.

New study shows climate impacts and mitigation could affect natural interest rate

Climate change may have “substantial” effects on the natural rate of interest, according to a new European Central Bank (ECB) literature review and analysis. Climate change and government policies to mitigate it could have macroeconomic effects on GDP growth, investment levels, productivity, inequality, demography and risk aversion, with consequent impacts on monetary and fiscal policy.

The study examined both short-term economic models, which do not usually incorporate environmental or energy-related effects, and long-term models which explicitly model the economic impact of climate change but do not address medium-term effects. “In most cases, we find that climate change would have a rather dampening effect on [the natural rate],” the authors conclude, calling for “increasing flexibility in the monetary policy strategy, both in terms of objectives and time horizon.”

Used as a benchmark for guiding monetary policy decisions, the natural rate is defined as the real rate of interest which allows the economy to operate at its full potential while simultaneously keeping inflation at its target.

Further calls for climate to be added to RBA mandate

The objective of supporting an orderly transition to net-zero greenhouse gas emissions should be added to the Reserve Bank of Australia’s (RBA) mandate, writes Oxford university researcher Toby Phillips in an article published in the National Tribune. The climate crisis is still nowhere near the centre of the deliberations of the RBA, he argues, with its current mandate focusing on the three objectives of price stability, full employment and “the economic prosperity and welfare of the people of Australia”.

“While it is beyond doubt that the third objective includes a liveable climate and a sustainable environment, not spelling this out relegates climate and sustainability to second-order status as the bank makes decisions,” says Phillips. He proposes adding a fourth objective requiring support for “an orderly transition to, and maintenance of, net-zero greenhouse gas emissions, and management of climate-related risks and opportunities”.

Phillips is programme director at the Centre for Policy Development, an independent think tank that has recommended updating the RBA’s legislative mandate to incorporate sustainability and climate risks.

Green transition may reduce inflation, says ECB’s Panetta

Greater use of renewable energy may help cut inflation compared to continued reliance on fossil fuels, ECB board member Fabio Panetta has said.

In a speech to the Italian Banking Association, Panetta pointed to Europe’s dependency on imported fossil fuels and the resulting exposure to price and supply shocks, as well as to the “huge cost” of climate change. Given that the ECB’s primary mandate is to preserve price stability, understanding the relationship between the transition to a greener economy and the price of energy is crucial, he said.

“Appropriate public policies that compress the demand for fossil fuels and stimulate the production of cheaper renewable energy sources can help to contain inflationary pressures and may even help to reduce inflation compared with a counterfactual situation. We are already using the lower cost of renewable energy to cushion the impact of the fossil fuel shock on electricity prices,” he said.

“If the green transition had happened earlier, it would have been easier to progress towards our climate goals and we would have reduced our exposure to the current energy shock and its inflationary consequences,” he concluded.

FSB Africa group discusses climatic effects on food security

The Financial Stability Board’s consultative group for sub-Saharan Africa has met to discuss climate-related risks and other vulnerabilities in the region. Hosted by the Central Bank of Kenya, the meeting examined global and regional challenges covering both economic and financial market issues, along with arrangements for crisis preparedness and management. It also reviewed progress of the FSB’s roadmap to address financial risks from climate change and its recent recommendations for regulatory and supervisory approaches to climate-related risks.

“Food insecurity is a growing issue both because of short-term supply constraints and more fundamentally through climate change,” the FSB said in a press release following the meeting, at which members discussed how food security issues impact financial authorities.

The regional group consists of representatives from 11 national financial authorities as well as the Central Bank of West African States and the Bank of Central African States. It is co-chaired by South African Reserve Bank governor Lesetja Kganyago and Bank of Ghana governor Ernest Addison.

PBoC to focus on transition finance, says deputy governor

The People’s Bank of China (PBoC) will explore transition finance instruments to support lowering emissions from carbon-intensive industries, deputy governor Xuan Changneng has said.

Reviewing the international growth of transition finance, Xuan said that some Chinese banks have already launched products aiming to “allocate more financial resources to areas with significant emission-reduction potentials”. Most of these products consist of transition and sustainability-linked bonds.

Xuan’s remarks follow the announcement of a joint taskforce created by the Monetary Authority of Singapore and the PBoC to deepen bilateral cooperation in green finance. The taskforce will explore collaboration in areas including standards and definitions, green and transition financing solutions, data and technology enablers, and enhancing green investment opportunities.

Review of Finance publishes special issue on sustainability

A special issue on sustainable finance has been published by the Review of Finance, the official journal of the European Finance Association. Topics covered include capital asset pricing, divestitures, and the effects of climate risk on the cost of mortgage credit.

Investors are still faced with “aggregate confusion” when trying to analyse the ESG score of a company, warns a paper on ESG ratings divergence. Another study explains that few US signatories to the Principles for Responsible Investment initiative have improved the ESG scores of portfolio companies after investing in them. Financial literacy and access to information determine green investment choices, another paper explains, with pro-environment households more likely to financially disengage than hold pro-environment portfolios.

Edited by Alex Edmans and Marcin Kacperczyk, the entire special issue is open access.