Realising Central Banks’ Climate Ambitions Through Financial Stability Mandates

Despite climate-related threats to price stability, most central banks address their climate ambitions only through financial stability mandates while ignoring monetary stability mandates, finds this paper from two European academic economists.

Following a review of the green central banking experiences of G20 countries over the past 20 years, authors Paola D’Orazio (Ruhr-Universität Bochum) and Lilit Popoyan (University of Naples Parthenope) reveal a mismatch between the observed policy practice of so-called market neutrality and its theoretical underpinnings. They argue in favour of a synthesis between monetary and macroprudential policy making in response to climate change.

Preserving central bank mandates and independence while mitigating climate-related risk is not an easy task, the paper acknowledges, posing the question of how monetary authorities and financial regulators get out of this institutional deadlock.

In answering this question, the authors review the evolution of monetary policy mandates over previous decades and discuss the channels of transmission of climate change to monetary policy. They then look at the diffusion of climate-related financial policies and address the role of financial stability governance models before examining the possible entanglements when monetary authorities institutionally embrace climate action.

Discussing monetary policy, the paper focuses on green quantitative easing, targeting refinancing operations and green collateral eligibility criteria. It shows that only the People’s Bank of China has a dedicated policy to promote green finance via monetary instruments. A review of existing financial policies finds no climate-related macroprudential measures concerning capital requirements, leverage ratios, systemically important banks or liquidity requirements in G20 countries.

The study emphasises that “the potential hurdles emerging from the interaction between monetary and financial policy require a rethink of monetary authorities’ and supervisors’ roles when dealing with climate change uncertainties and their effects on central banking”.

It concludes by arguing that effective green central banking governance should be based on a synthesis between monetary and macroprudential policymaking, allowing central banks and regulators to realise their climate-related ambitions within existing monetary policy mandates.