Central bank independence should be reframed in light of climate change, say economists

In the face of climate change, it’s time to rethink central bank independence, two prominent economists told Green Central Banking.

Speaking on the sidelines of the Finance for Society Forum in Brussels, economists Geoff Mann and Ann Pettifor emphasised that economic policy, including the role of the central bank, needs to be reframed if there is to be a viable solution to climate change.

“I’m not comfortable with the idea that somehow a central bank can remain independent in the way that the independence has been framed now and actually contribute more than marginally to the climate struggle,” said Mann.

History of central bank independence

Central bank independence has been questioned by conservatives in the US, with President Donald Trump repeatedly attacking the Fed.

That criticism is not unfounded, especially if there is a desire for institutions like central banks to do more than just set inflation targets, says Mann. Many issues around inequality and climate change accelerated when central bank independence became the norm during the 1950s.

“The very fact that most central banks now feel obligated to constantly manipulate the markets is actually exercising a power that we would have traditionally thought of as being fiscal in nature, but now we see it as absolutely essential to what a modern central bank does,” he said.

The idea of central bank independence is a relatively new concept and became popular with US Federal Reserve chair Paul Volcker who clamped down on credit during the 1970s financial crisis, said Pettifor.

“Talk of central bank independence only became clear with the crisis caused by Paul Volcker in the early 1970s when easy money fueled an unsustainable credit bubble, which then crunched. It was at that point that the ideas of austerity and central bank independence began to take shape,” she said.

But originally central banks were created to help finance wars and help the state, not private markets, she said. Before the 1951 Treasury-Fed accord, the US central bank was actually an arm of the White House and Treasury.

Central banks and green finance

Both Pettifor and Mann acknowledge that getting rid of central bank independence could mean the institutions are at the power of politicians who might want to use them for other means.

The key, says Pettifor, is balance.

“You cannot have monetary policy fighting fiscal policy, which is what we have in Britain. This is not to say that we must have political control,” she said.

Trump’s grievances that the Fed is at the whims of Wall Street are true, Pettifor said. But his way of going about it and what he wants to do with the central bank are not accurate.

Ultimately, the central bank can be used to help the transition to a green economy.

“The fossil fuel sector would not be where it is today without the finance sector. So I regard the finance sector as more powerful than the fossil fuel sector,” said Pettifor.

One way to help finance the green transition to a green economy is to understand central banks’ power and use collateral as a carrot for encouraging investments away from fossil fuels, said Pettifor.

Some of the safest collateral are US treasury bills, euro bonds and British gilts, which financial institutions want access to. So why not dictate that banks can only get access to that safe collateral if they are not investing in fossil fuels, she said.

Finance is a powerful tool that can be used to reshape society, added Mann.

“Central bankers need to understand that they are political actors, not technical actors,” said Mann.

“They need to act with the discretion and judgement that a responsible political actor would use, not a technocrat bound by a series of rules that were written for a different era, but also for a world we don’t want to live in”.

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