The Network of Central Banks and Supervisors for Greening the Financial System (NGFS), a grouping of central banks and financial regulators, was formed in 2017 and now boasts more than 60 members ranging from large global players such as the European Central Bank, the People’s Bank of China, and the Bank of Japan to relative minnows such as the Serbian and Seychelles central banks. One notable absence is the American Federal Reserve, which left the NGFS in January this year.
The Network describes its aims as:
…to share best practices and contribute to the development of environment and climate risk management in the financial sector and to mobilize mainstream finance to support the transition toward a sustainable economy.
The Fed’s decision to leave was widely regarded as an attempt to curry favour and/or to avoid criticism from the new White House team, which came into office in January.
Whilst few economists would dispute that climate change is a major global issue and one that will no doubt have major economic implications over the coming decades, it’s relevance to monetary policy – at least in the short term – is far less clear.
Climate change is not a distant threat – it is a current reality reshaping our economies and financial systems. Understanding the immediate impact of climate-related risks has thus become an urgent necessity for central banks and other financial actors.
Some of its scenarios – which involved both climate-related weather changes and differing paths of moving different states and regions towards net zero carbon emissions – threw up material impacts on both GDP and inflation. These were, of course, scenarios rather than forecasts.
Last week, the Clark Center’s Finance Experts Panel offered its own views. It is fair to say that the experts were not especially convinced of the argument that climate risk will be a major concern of central banks in the years immediately ahead.
The panel was first asked whether “under current policies on climate change, the associated physical risks (such as those arising from total seasonal rainfall and sea level changes, and increased frequency, severity, and correlation of extreme weather events) will be at most a very small factor in monetary policy decisions over the next decade”. Weighted by confidence, 52% of respondents either strongly agreed or agreed, whilst 33% were uncertain. Just 15% of respondents disagreed.
John Cochrane, who strongly agreed that climate risks would likely be a small factor when it comes to monetary policy in the decade argued that: ‘You have to have a very expansive view of monetary policy and technocratic capacity (with 10% inflation in the rear view mirror) to draw a connection between the overnight federal funds rate and slow moving co2 related changes in the probability distribution of the weather.’
Of course, much depends on exactly how materially the impacts of climate change begin to show up in the coming ten years. As Campbell R. Harvey of Duke put it, ‘while climate plays little or no role in current policy, the question is about the next decade. If the frequency of extreme events continues to increase, it is plausible that there could by systemic events that become more than a “small factor for monetary policy.”’
And as Janice Eberly of Northwestern Kellogg noted, if climate risks do materialise in the form of an economic shock, one would expect policy to respond. ‘Even if policy does not explicitly target climate risks, those risks may appear as economic shocks. Monetary policy has responded strongly to external shocks, such as the pandemic, when they are large enough, regardless of origin’.
Nor were the experts convinced of the relevance of climate change to financial stability, although here the consensus was weaker. Asked whether ‘The physical risks associated with climate change under current policies are likely to threaten financial stability over the next decade’, 47% of respondents (again weighted by confidence) either strongly disagreed or disagreed, whilst 38% were uncertain.
On this matter, some of the respondents noted that if risks from actual changes in weather patterns were unlikely to be a risk to financial stability, wider climate change policies could be. As Anil Kashyap of Chicago Booth argued, ‘The transition risks from policies that change the price of carbon are VERY different matter and those could create lots of stranded assets’.
Jonathan Parker, of MIT Sloan, made the useful distinction that even if overall financial stability was unlikely to be threatened by climate risks, individual institutions might still be in some danger. ‘Under the types of regulatory policies that we’ve seen in the past decade, our financial sector is well protected against climate disasters. But not all institutions are safe. Insurers face significant risk’.
Interestingly, the US Experts Panel was asked similar questions back in 2019. The panel’s views on the impact of climate change on monetary policy have not shifted much, but five and a half years ago, they were a touch more concerned about the financial stability risks.
As one respondent put it then, the risks are more likely to materialise, ‘not over the next decade, but within 2 or 3 decades’. Until then, climate is likely to remain a major area for policy overall, but perhaps not a major concern of central bankers.
