Fundi Tshazibana, vice-chair of the Network for Greening the Financial System and deputy governor of the South African Reserve Bank. © South African Reserve Bank
This is part two of our Green Swan 2024 coverage. Read part one.
Central banks are being forced to rethink their traditional approaches as the climate crisis poses unprecedented challenges to price stability, panellists said during a session at the recent Green Swan conference.
The panel, moderated by Fundi Tshazibana, vice-chair of the Network for Greening the Financial System, warned of an increasingly volatile inflationary environment during the green transition, and called for innovative monetary measures such as green credit policies.
Roberto Campos Neto, governor of the Banco Central do Brasil, explained that climate change is compelling central banks to reassess their traditional remits. “The climate is our mandate,” he said, citing Brazil’s frequent encounters with climate-related weather events impacting price and financial stability over the past year.
Professor Veronica Guerrieri of the University of Chicago compared the green transition to the industrial revolution, highlighting the substantial economic restructuring ahead. She stressed that despite challenges, the costs of inaction on climate would be far higher.
“During the green transition … necessarily there is going to be pressure towards higher inflation,” she said. “These costs are necessary because the green transition is going to imply a big transformation of the economy, a big collapse of some sectors and emergence of others.”
Guerrieri presented research suggesting a more complex relationship between inflation and unemployment will unfold during the green transition, as increased carbon pricing generates asymmetric negative supply shocks. Within this new dynamic, for any given level of unemployment inflation is likely to be higher than before.
As a result, Guerrieri said, “the menu available to central bankers is getting worse”.
In light of these challenges, Guerrieri proposed a temporary departure from traditional approaches may be necessary if “we don’t want to sink our economies”. By accepting somewhat higher short-term inflation during the transition, she argued, central banks can stabilise employment and expedite the transition process, mitigating more severe future climate-related price shocks. However this comes with a risk that inflation expectations are de-anchored.
Impacts of monetary policy on green R&D
In a thought-provoking question, Mário Centeno, governor of the Banco de Portugal, asked Guerrieri: “What does [a nominal anchor] mean … when the world is sinking and relative prices are changing, sometimes abruptly? How can we think about the nominal anchor in such a dramatic world?”
Guerrieri floated the ideas of higher inflation targets, which she later hinted could be around 3%, and extending projection horizons as potential adjustments.
She also recognised that redistribution of carbon revenues towards green innovation can foster productivity growth and output, with deflationary effects.
However, a key insight from the discussion was the sensitivity of green investments to monetary policy. “Green investment in R&D responds negatively, dropping in response to contraction of monetary policy in a sizable way, while R&D investment in dirty firms or non-green firms actually barely moves,” said Guerrieri, referencing research data.
She explained that this finding raises concerns about tight monetary policy impeding technological progress in green sectors, with adverse effects on long-term productivity – potentially prolonging inflationary pressures.
The panel agreed that coordinated fiscal and credit policies that subsidise green investments may provide a more fruitful avenue for addressing inflation in this impending climate reality.
Campos Neto suggested that macroprudential tools may be required to deal with the climate crisis. “Should we be, for example, charging [a] higher price of capital for banks that have non-green investment?” he asked. Given that climate change represents an “extreme case”, such measures would not necessarily contradict the basic principle of separation around monetary policy and prudential policy, he argued.
In her closing remarks, Tshazibana challenged central bankers to assess the appropriateness of traditional monetary assumptions and policy frameworks in light of the green transition. She emphasised the need for more sophisticated modelling incorporating both transition effects and climate events to produce more “dynamic reflections”.
As they grapple with the dual challenges of climate change and economic stability, Tshazibana invited central bankers in the audience to explore what coordination between fiscal and monetary policy “looks like in practical ways” in their own jurisdictions.
This page was last updated November 20, 2024
Written by
Ike Walker, a Green Central Banking contributor since 2023, has a decade's experience in research writing. An Utrecht-based scholar, Ingrid specialises in transformative justice, green finance, law and systems change. They are an Utrecht University's Bright Minds scholar and previously worked for Cambridge University and various justice-based NGOs.
