Central Banks and Climate Change

Discussions of central bank action on climate change and its associated risks are heavily influenced by the arguments of those opposed to such action which focus on mandates, independence, neutrality and legitimacy. This paper from the European Banking Institute’s working paper series proposes a systematic methodology to clarify this debate, and to analytically and sequentially address objections to climate action.

Using a comparative analysis of central banks’ mandates and central bank-related case law, this wide-ranging paper explores vitally important but often controversial issues in a structured and systematic way. It also employs interdisciplinary insights from network theory, decision theory under uncertainty, and social norms.

The authors – all professors at the Universidad Carlos III de Madrid – distinguish between three types of objections to central bank action on climate, focusing on what they’re allowed to do by their mandates “fit”, when they should act (“opportunity”), and how they should act (“suitability”). They also propose a second-level distinction between how central banks might analyse these arguments and how the courts could assess them when evaluating the lawfulness of an action or inaction.

The paper makes clear that objections about the abandonment of so-called market neutrality and other climate-based policies would jeopardise central bank independence suffer from a lack of symmetry, largely because they ignore future costs. “Ignoring a phenomenon because its effects lie in the future is not ‘market neutral’ if that means more intrusive, less planned, intervention at a later stage.”

There is also a simplifying assumption that a warmer future presents no threat to central bank independence, when in reality pressure on central bankers will likely increase. Another assumption is that climate-focused policies mean a more subservient role for central banks in relation to governments. In reality, however, the reverse is more likely to be the case.

In an Oxford Business Law blog post, co-author David Ramos Muñoz summarised the paper, focusing on key arguments. Climate change directly threatens price and financial stability, the “core” denominators of central bank mandates, he writes, calling for proportionality analysis and inclusion of the costs of inaction in central bank analyses.

“An increasingly thick pile of evidence suggests that the cost of action is much lower than the cost of inaction,” he says, pointing to the slow evolution of social norms as an explanation for the “long-standing passivity” of central banks.

“A methodical, step-by-step analysis of the different arguments shows that central banks may, and should, integrate climate change considerations as part of their mandate, that they should be proactive, and that they should adjust their toolkit with precision,” Muñoz concludes in his blog. “They should accompany this adjustment with a clear communication strategy to signal their precommitment, allowing market expectations to do their part.”