Climate Policy at the Bank of England

Possibilities and Limits of Green Central Banking

February 13, 2024Published by Climate Policy

The Bank of England (BoE) should adjust its hierarchy of priorities to protect green initiatives during monetary policy tightening, finds this paper for Climate Policy. The paper also highlights the importance of governments setting explicit transition pathways to provide greater certainty and political legitimacy for central banks managing climate risks.

While the BoE’s more climate positive policies of the last decade have departed from policymaking as usual, there has not been a “paradigm shift” in its institutional goals, according to author Monica DiLeo.

DiLeo assesses the possibilities and limits of green central banking in the UK by exploring the “institutional operations and norms” that paved the way for greater climate action from the BoE. She uses qualitative analysis of publicly available documents and speeches by BoE officials between 2001 and 2022.

The results show that the post-global financial crisis (GFC) macroprudential framework, with its greater focus on financial stability, provided the primary interpretive context that connected the bank’s objectives with its climate policy.

The bank’s climate remit was furthered by supportive government policy and legislation that created a clear and “democratically endorsed transition pathway”.

Annual remit letters were also used by the UK’s chancellor in 2020 and 2021 to give the BoE an explicit environmental mandate.

While these developments facilitated a more active policy approach, they positioned measures as part of the post-GFC push to manage systemic risks, so the bank’s climate mandate never achieved priority status. This threatens the durability of climate policy in inflationary environments, says DiLeo.

To make sense of the possible climate policy pathways for central banks, DiLeo uses a three-part conceptual framework: normal policy making, “thermostatic innovation” and a green paradigm shift.

This framework categorises approaches based on their scope and durability, and distinguishes between promotional and prudential policies. The former refers to policies that directly alter credit allocation.

Within the business-as-usual framework, banks achieve durable changes with limited scope by fitting climate within existing prudential frameworks and avoiding distributional credit policies.

DiLeo argues that the BoE pathway goes beyond this approach as it has “emphasised the ‘distinctive’ nature of climate change as an existential risk that requires a novel and potentially far-reaching approach”. This is shown by the BoE’s decisions to tilt its corporate bond portfolio and consider risks beyond the typical three-to-five year horizon.

Instead, DiLeo characterises the BoE approach using the thermostatic policy innovation model, which mixes promotional and prudential policies.

In this scenario, a bank’s policy paradigm is not transformed but is maintained through significant policy innovations. Here, the hierarchy of priorities remains firmly intact, and so policy innovations, though potentially wide in scope, remain strictly subordinate to institutional priorities.

This dynamic can be observed in the BoE’s decision to end the green tilting of its corporate bonds in 2023, stepping away from the more promotional aspects of its green agenda during a period of monetary tightening.

DiLeo concludes that, unlike central banks in some developing economies, such decisions demonstrate that the BoE has not undergone a green paradigm shift.

This page was last updated February 13, 2024

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