Monday

26th Sep 2022

Analysis

Can the ECB solve climate change and inflation on its own?

  • A melting ice sculpture spelling 'Future' (in German) outside the ECB HQ in Frankfurt (Photo: Greenpeace)
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The European Central Bank (ECB), through its monetary policy, has shaped the response to the Covid-19 pandemic - and, with it, the current state of the economy - more than any other EU institution.

Essentially endless amounts of cheap cash under its pandemic emergency purchase programme (PEPP) and negative interest loans to commercial banks (the targeted longer-term refinancing operations, or TLTROs) prevented a financial crisis during the outbreak.

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The current economic outlook is better than it has been for years, but its policies have also resulted in side effects. For example, low rates have led to house-price inflation and the ballooning of other financial assets. And its bond purchasing also financed fossil-fuel companies.

NGOs and MEPs have frequently called on the bank to develop monetary policies that promote a shift to the environment, instead of supporting fossil fuels.

But - as stipulated in the European treaties- the ECB can design and implement monetary policy independent from governmental interference, which has resulted in an organisation that can more or less act on its own accord.

However, as the economist and philosopher Jens van 't Klooster, postdoctoral fellow at the University of Leuven recently argued, more coordination with democratic authorities might be preferable, especially in response to the climate crisis.

Fixing climate is part of mandate

In the study, van 't Klooster and assistant professor of constitutional law at the University of Amsterdam, Nik de Boer, question the bank's overriding focus on price stability and argue it should instead coordinate its climate and monetary policies with governments.

And it can achieve this without changing the treaty, simply by interpreting in more detail what the bank's secondary mandate actually means.

Under its treaty, the bank has two mandates which set out its objectives.

The primary mandate takes priority and tasks the bank with maintaining price stability, which the ECB established at an inflation level of two percent.

Its secondary mandate directs the bank to "support the general economic policies in the Union" - which are vaguely defined as promoting social justice, economic growth, full employment and quality of the environment.

According to de Boer and van 't Klooster, it is unclear how the bank is deemed to achieve these goals - because the secondary mandate does not rank the objectives.

What also doesn't help is that the ECB itself has only mentioned this secondary mandate 10 times in 21 years. "Neglecting the secondary mandate may be illegal, and in any case, it is not desirable," van 't Klooster says.

"The ECB currently sees climate change mainly as a threat to price stability, but you can question if this is the most direct or effective way of tackling the problem of climate change," de Boer said to EUobserver.

In fact, on Thursday (25 November), executive member Frank Elderson did not describe the threat of climate change solely as a financial risk but called it the "single most defining issue for humankind."

The ECB has already raised the alarm that not a single one of the 112 commercial banks the ECB oversees "is on a Paris-compatible trajectory."

But the bank neglects to fully address some of the monetary policy's economic, climatic, and societal effects.

"Should the ECB buy bonds in fossil fuels? Should it do more against house price inflation? Why does it own €3.6 trillion in government debt? These are questions that cannot be answered merely by saying: we pursue price stability," van 't Klooster said.

He points out a new direction for coordination between government and the central bank is suggested in a recent ECB background study.

Chiara Zilioli, and other members of the ECB's directorate-general of legal services, argue that the European Council, the Council of Ministers and the European Parliament are primarily responsible for indicating the bank's priorities.

Coordination with these EU institutions will help to navigate the dual challenge of inflation and climate change.

Inflation trumps climate change?

With inflation hitting high marks around the globe, pressure on central banks to boost interest rates have mounted.

Christine Lagarde, the French president of the ECB, has so far ruled out raising interest rates. But Australia, South Korea, New Zealand and other countries have already lifted rates.

Higher interest rates hit the entire economy, not just the parts where prices are high. It also raises borrowing costs for climate-related projects right where investments are needed most.

"It would be deeply problematic if raising interest rates, to fight short term price developments, would harm investments that comply with the Green Taxonomy," van 't Klooster tweeted on Monday.

An example of what coordination between monetary and fiscal policies might look like are Green TLTRO's.

It is an idea proposed by van 't Klooster, who wrote a paper about it for the NGO Positive Money. Over the last year, it has steadily grown in popularity among economists and policymakers and is now starting to reach the political scene.

Like regular TLTROs, their green counterparts would provide negative interest loans to commercial banks, provided they lend to green projects like home isolation or clean energy start-ups - essentially protecting green investments against possible rate rises.

Referring to the study, MEP Aurore Lalucq (S&D) recently told Lagarde "there is no time to lose" and pressed home the need for Green TLTRO's "as a much more effective tool against inflation."

And although Lagarde made clear that she has "pushed as much as she could in that direction" and did not want to "close the door on green TLTROs", she said it was not yet something the governing council wanted to consider," maintaining that "we have to be agile and able to adjust if need be."

Market neutrality hinders climate policy

The problem is that Green TLROs clash with the idea of market neutrality.

The concept of market neutrality itself is set for review in 2022, potentially changing the rulebook for ideas (such as Green TLTROs) that direct money towards environmental investments.

The question remains whether the governing council has enough legal basis for deciding what should take precedence.

According to van 't Klooster, climate change is too important to leave solely to the governing council, and the effects of monetary policy on society and the environment are too great.

"The world isn't getting any more democratic," van 't Klooster says. "Besides, 'market-neutrality' only means buying up more Shell bonds."

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