Price stability requires more climate action from the ECB

February 15, 2024|Written by |De Nederlandsche Bank, European Central Bank
Euro notes of varying denominations
Price stability is threatened by climate change and environmental degradation. © Mabel Amber

Blessed is the country which has a central banker who can distinguish the wildflower of the rattler from that of the marsh helleborine. Frank Elderson on the board of the European Central Bank (ECB) is such a person, as became apparent in a recent interview with Dutch newspaper De Volkskrant in which he spoke about his botanical knowledge.

Now that price and financial stability are threatened by both climate disasters and the ever-accelerating deterioration of nature, this is not unimportant.

Elderson warns that central bankers should not bury their heads in the sand and ignore this. Under Elderson, first De Nederlandsche Bank and now the ECB have led the world in recognising and investigating these risks. This sets the tone internationally.

However, the impact of all this on what supervised financial institutions do has so far remained limited. While climate shocks grow and biodiversity declines rapidly, insights about these threats are only slowly seeping into supervision and monetary policy. Unfortunately, the ECB’s new climate and nature plan presented last week mainly contains intentions for even more research.

Such research will never be able to provide certainty about the fundamentally uncertain effects of climate and natural disasters. The precautionary principle dictates that you do not wait until you know everything, but that you act to prevent yourself ending up in a situation from which no rescue is possible. This is exactly how we saw central banks act in the 2008 financial crisis, the euro crisis and, most recently, the Covid crisis.

Unfortunately, when it comes to climate and nature the actions taken are completely different.

The ECB may start fining the worst performing banks this year, even though not one of the banks complies with the ECB guidelines presented almost four years ago. Banks are therefore now not required to hold additional capital to cover climate risks, undermining financial stability. The nitrogen crisis that is currently holding both the Dutch economy and political landscape hostage could never have become so bad if the banks had been required to hold extra capital for new stables near nature reserves. Expansion would then have become considerably more expensive for farmers.

Due to the climate case brought by campaign group Milieudefensie against ING, a Dutch judge must now rule on the soundness of the bank’s climate plan. However, as supervisor of climate transition risks the ECB should already have this assessment ready.

A marsh helleborine flower
One ECB board member knows a marsh helleborine when he sees it. © Bjorn S

In this way, the financial sector cannot be the “flywheel” of sustainability, as former Dutch finance minister Sigrid Kaag called it. Oil companies are still getting loans for new wells – wells that science says are incompatible with limiting climate change. The financial sector is therefore a brake on the transition. And, if the transition is accelerated as necessary, a lot of money will be lost. Guess who will save the still “too big to fail” banks.

High interest rates threaten price stability

The ECB’s promise to achieve a monetary policy that is in line with the Paris climate agreement has so far only led to minor adjustments. Meanwhile, the Chinese and Japanese central banks offer lower green interest rates for sustainable loans from banks. That could really make a difference.

Such an incentive is also desperately needed in Europe, because sustainable investments in particular suffer from the increased interest rates. Viewed over the entire life cycle, sustainable energy is often cheaper than fossil energy once the windmills, solar panels, heat pumps and electricity cables are in place, the sun will rise for nothing and the wind will blow for free. But the investment costs are still considerably higher and sensitive to interest rates.

Research by consultants Berenschot showed that, due to increased interest rates, the costs of the energy transition in the Netherlands up to 2030 have increased by as much as €17bn. Every further percent increase in interest rates pushes up these costs by €6bn, reaching €55bn by 2050 at current rates. The high interest rates thus slow down the energy transition. A third of the members of the Dutch Sustainable Energy Association indicated that they had already cancelled or postponed projects.

High interest rates therefore also pose a threat to price stability because they make Europe dependent on fossil energy for longer. The last inflation peak was the result of rising oil and gas prices, as the next one might also be. With tensions rising in the Middle East and elsewhere, there is every reason to accelerate the energy transition precisely because of price stability.

The ECB is expected to cut interest rates later this year. Do that first or deeper for the green loans from banks. European politicians have drawn up an extensive list – the green taxonomy – that can be used for this purpose. Start with loans for which data is already available, such as making buildings energy efficient and investing in sustainable energy sources.

In this way, the ECB accelerates the energy transition and thus protects price stability. Exactly what we have a central bank for.

This is a translated version of an article that first appeared in De Volkskrant.

This page was last updated July 4, 2024

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