The most important nugget in Rishi Sunak’s March budget was not the size of ongoing stimulus measures nor the nod at retrenchment to come. It was the chancellor’s announcement that the Bank of England’s mandate will now include supporting the government’s net-zero emissions target. This move marks a sea change for central banks.
It’s not surprising that the UK is ahead of the pack in taking this step. The BoE led the way in encouraging corporate disclosure of climate risk and will soon conduct climate-related stress tests. It is relatively uncontroversial to assert that central banks have a supervisory role to play in assessing the risk from climate change. Even the US Federal Reserve—a relative laggard on green initiatives—recently created the Supervision Climate Committee to co-ordinate its work to this effect.
The question is whether there is a real monetary policy role to play too, such as purchasing green assets or actively supporting lending for green investment. One problem is that central banks still operate on a short-term basis—the Federal Reserve and European Central Bank only provide three-year forecasts, the BoE four—and climate-related crises are impossible to forecast in the short term.
Some, such as Bundesbank president Jens Weidmann, argue that an active role combatting climate change could undermine a central bank’s independence so that it can no longer pursue its primary goal of price stability. Climate change, the argument goes, is a slippery slope—sooner or later there will be pressure to incorporate some other political objective, and before you know it independence has effectively vanished.
At the heart of this argument is the notion that central bankers are not democratically elected, so should not choose winners and losers. But in reality they already do: the very act of cutting interest rates—the most basic act of monetary policy—benefits borrowers, while hiking rates will benefit savers. Unconventional policies to purchase particular assets make winners out of those holding them. Central banks are already political: they might as well help ward off humanity’s looming existential crisis.
As things stand, central bankers may actually be contributing to the climate crisis. Many are concerned about maintaining market neutrality and avoiding bias towards certain industries. But as ECB president Christine Lagarde points out, markets do not adequately price climate risk. If the ECB maintains market neutrality, it is just exacerbating this market failure.
The BoE may not be the last central bank to incorporate climate change. The ECB is undergoing a strategy review this year. It may turn out that its mandate to support the economic policies of the eurozone already allows it to consider climate when determining monetary policy.
For investors, all this means the market failure in pricing climate risk should slowly dwindle. Fossil fuel equities will suffer and companies employing renewables will rally. The ESG (environmental, social and governance) movement is here to stay, and Europe will continue to revise taxonomy to identify companies that do well on this front. With an administration committed to climate action, the biggest market swings of all may be in the US, as regulatory agencies and the Fed play a greater role. For now, however, the UK remains ahead of the curve.
