4th Feb 2023

Monetary austerity risks derailing EU green agenda, economists warn

  • The ECB has raised rates by 2.5 percent since the summer (Photo: ECB)
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The European Central Bank on Thursday (15 December) announced it would continue its monetary austerity stance and keep on raising rates "at a steady pace."

"We are in for a long game," bank president Christine Lagarde told press in Frankfurt. "Interest rates will still have to rise significantly at a steady pace to reach sufficiently restrictive levels to ensure a timely return of inflation."

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The governing council decided to raise interest rates by another 0.5 percent, bringing the main interest rate to 2 percent, with a further increase expected in the first quarter of next year.

Raising rates only affects domestic demand and does not directly influence the price of imported energy and food, which are still the two main drivers of inflation.

"There is still very little evidence the ECB can bring down actual inflation," wrote Carsten Brzeski, the head of macro at Dutch bank ING, in a blog post on Thursday.

According to to former ECB vice president Vitor Constâncio higher borrowing costs "will aggravate the coming recession unnecessarily."

Jens van 't Klooster, an assistant professor of political economy at the University of Amsterdam, has also identified a deeper risk of indiscriminate rate hikes.

By raising the cost of capital across the board, the ECB risks derailing European efforts to accelerate green investments needed to replace Russian gas.

"Raising interest rate may bring inflation down in one or two years, but would cut off investments in renewable energy, energy efficiency and climate adaptation," he tweeted.

Green investments are particularly costly and require larger upfront investments than fossil fuels.

Increasing capital cost worsens clean tech's competitiveness compared to fossil fuels. This would slow down deployment of renewables, which Fatih Birol, director of the International Energy Agency, recently said is the best way to bring energy prices down.

Higher rates especially undermine energy efficiency and home renovation investments, which are often financed by more expensive consumer loans.

Households thus face a "double challenge," wrote Uuriintuya Batsaikhan, an economist at the Brussels-based NGO Positive Money in a recent blog. "A higher cost of credit for renovation loans and a higher cost of materials and service because of soaring inflation."

In a paper published in July for the Grantham Research Institute on Climate Change and the Environment, in 't Klooster argues the ECB could prevent this by offering lower interest rates for sustainable investments while maintaining its higher rates for other financing operations.

This can be done by revising its Targeted longer-term refinancing operations (TLTRO). By differentiating interest rates in 't Klooster wrote: "the ECB can minimise the undesirable side-effects of raising interest rates, and promote long-term monetary and financial stability."

Lagarde in the past has signalled openness to so-called 'green-TLTROs', but said it was "not yet something the governing council wanted to consider."

Moreover, the ongoing dispute with Washington over the Inflation Reduction Act (IRA), a massive package of protective subsidies and tax breaks for US clean technology, requires the EU to do something equally attractive.

But an increasingly hawkish stance potentially sets the ECB on a collision course with commission president Ursula von der Leyen, who has called on EU leaders to massively increase green spending to compete with the US and China in the race to net zero.

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