Monetary, fiscal coordination needed to address climate change in EU

Key points

• Economists say central banks cannot tackle climate-driven inflation and supply shocks alone, urging closer coordination with fiscal policy.

• Higher interest rates can squeeze public spending and make green investment more expensive, prompting calls for a lower green rate and expanded ECB green collateral rules.

• The European Commission warned that extreme weather is already hitting revenues, spending, growth and public budgets.

• ECB research found heatwave-hit regions see activity fall by 1.5% after two years and 3% after four years, strengthening the case for both adaptation and decarbonisation.

---

 

Europe cannot rely on central banks alone to manage the economic fallout from climate change, economists warned at a European Parliament panel, calling for closer coordination between monetary and fiscal policy.

“Coordination between central banks and government is not something new. It’s something that’s happening already, but in much more of a kind of reactive sense,”
said Jaya Sood, a senior economist at the New Economics Foundation in London, during a panel organised by the New Economics Foundation and cross-party group of MEPs..

Sood highlighted the ability for governments to use targeted fiscal measures to address price pressures, rather than leaving it entirely to central banks to solve.

“This is just about coordination on being on the front foot versus coordination that sort of comes from crises.”

While the European Central Bank (ECB) has taken steps to green its collateral, monetary policy alone can’t address the supply shocks from climate change. Adding to the complication is that increased interest rates could constrain fiscal spending, according to Romain Svartzman, a professor at Bocconi University and former economist at the Banque de France.

“When there are increasing interest rates, you usually have a decrease of fiscal spending, government expenditure on key sectors, be it health, climate and population age in general,” he said during the panel.

Increased rates can also make borrowing more expensive for green projects. Campaigners have been pushing for the ECB to consider a green interest rate, or a rate that is lower than the threshold if applied to transition projects, to increase investments in renewables. 

Another potential way to address the impact of interest rates is for the ECB to expand its green collateral framework to include sovereign bonds, Svartzman said. The ECB could also to reconsider how forward-looking it views inflation targets, as central banks tend to only consider inflation targets over the medium term of one to three years.

But if inflation is generated by a dynamic that will increase climate resilience in 5, 10, or 15 years, “do you still want to increase interest rates?” he asked.

Nicola Gagliardi,  senior economist at the Directorate-General for Economic and Financial Affairs at the European Commission, said the commission is aware of the economic and fiscal impact of climate change and that the “impacts on the public budget… is really clear-cut” as disruptions from extreme weather events could mean lower incomes and more uncertainty.

“All this turns into impacts on expenditure, clearly on revenues and on growth… whether we look at physical or transition risks,” he said.

The panel was held just a few weeks after European Commission president Ursula von der Leyen announced a new framework for climate resilience would be released in late October.

Irene Heemskerk, head of the climate change centre at the European Central Bank, welcomed current efforts in Brussels to look at climate adaptation but warned that “we cannot live in a 3 Celsius world so we should not lose sight of still making the transition happen”.

While the EU economy has so far been resilient to increasing energy prices and the stresses from the summer’s extreme weather, ECB research shows that economic activity in regions hit by heatwaves is, on average, 1.5% lower two years later and 3% lower four years later. 

Economists have estimated that the 2026 barrage of heatwaves could decrease the EU economy by at least 1%, with larger losses in areas hit harder by the summer’s unbearable heat such as France and Italy. 

While the heatwaves caused a decline in renewables in some countries, those in the EU bloc that have a mix of renewables have been hit less by energy prices, Heemskerk said, which “makes the case for making the transition happen”.

The ECB is going “step-by-step” with what it already has in place, even as there is a lot of uncertainty about climate change and the transition, Heemskerk said. It has still “stayed the course” on climate issues as its efforts have been “anchored within our mandate”.

She added: “When we published our climate and nature update or strategy in January, this was the message, and we stayed the course because we see there’s an increasing impact.”

Written by