Why the Fed and ECB Parted Ways on Climate Change

A supportive domestic environment has enabled the European Central Bank (ECB) to emerge as a climate policy leader, while the Federal Reserve has continually lagged behind the global consensus. In this paper, researchers explore the divergence between these historically similar banks and find that the polarised political environment in the US has hindered the Fed from considering climate “in any meaningful way”.

Central banks engage in complex practices to develop collective policy standards or “norms” due to their unique status as both independent and delegated domestic agencies and caretakers of the global financial system.

To explore how central banks internalise new climate norms in the context of domestic and international pressures the authors – Monica DiLeo, Glenn D. Rudebusch and Jens van ’t Klooster – use a two-tier analytical framework. First they consider the process of norm emergence, then they assess how norms “cascade” across international institutions.

In the norm emergence stage, broad support across the EU for climate action, along with persuasive action by thinktanks, researchers, and other “policy entrepreneurs”, enabled the ECB to lay the foundations of climate-related norms. Namely, that the macroeconomic and financial impacts of climate change are directly relevant to central bank core mandates.

From 2015, many central banks committed to these foundational norms and collaborated in global agenda setting forums such as the G20 and Financial Stability Board to instruct international regulators. The authors highlight climate-related stress tests, research and inflation forecasts as key measures associated with this foundational standard.

Meanwhile, in the US the Trump administration withdrew from the Paris Agreement which, the authors say,  restrained the Fed’s interest in climate. Additionally, the Fed faced a polarised political environment, well-funded fossil fuel lobbying and a “near silence of policy entrepreneurs” which catalysed the beginning of the Fed-ECB climate divergence.

At the secondary phase, norms exert stronger influence as they “cascade” through the global system. The founding of the Network for the Greening of the Financial System (NGFS) in 2017 exerted significant pressure towards convergence in central banking. And from 2019 the NGFS accelerated ambition by advocating for new climate-informed prudential and risk management tools.

The EU parliament endorsed this more ambitious and “proactive” approach, and in December 2019 the EU’s green deal enacted legally binding climate objectives. This empowered the ECB to adopt proactive policy including climate criteria for asset purchases and far-reaching supervisory interventions.

However, the Fed has limited itself to modest foundational policies and has avoided proactive measures. While the Fed took an important step by joining the NGFS in 2019, the authors say that an influential fossil fuel industry and partisan domestic politics continue to curb progress.

The authors state that while they expect sustained pressure towards convergence, they do not expect the Fed’s stark divergence from the ECB’s proactive stance to disappear soon. However, it is likely to increasingly cooperate with international peers on less overt regulatory interventions.