The ECB is getting serious about climate risk
Since Christine Lagarde took office as ECB President in November 2019 the European Central Bank started to focus ever more on climate change, specifically on its impact on the whole economy. As part of the effort made in this area, on September 22nd the ECB published the results of its economy-wide climate stress test – an exercise conducted on more than four million firms worldwide and 1,600 euro area banks. As expected, the test shows that the benefits of early adoption of green policies, i.e. limiting the medium and long run disruption to our economies (and livelihoods) brought by climate related shocks, largely outweigh the costs needed to implement them.
The ECB wants to make its part. From its point of view, tackling climate change may primarily mean adjusting its corporate bond purchase program in order to prioritize green emissions. But targeting properly the right issuers may prove very tricky. For example, excluding polluting companies from the program might deprive such companies of the funds needed to convert and adjust their processes. The result would thus be the opposite of what was aimed for. The ECB has therefore pledged to investigate further and come up with effective solutions.
But has the ECB the legal right to get involved in the fight against climate change? Critics like to argue that this is a pure political topic; on the other hand, the central bank should only focus on the primary goal of its mandate, i.e. price stability. But the truth is that the ECB has not only the right, but also the duty to take part in this process. Two main reasons stand out.
The first one is that in addition to its primary objective of price stability, the ECB has also a set of secondary goals. Among them is favouring the general economic policy of the union. This means that, as long as the European Union aims at becoming a zero-carbon economy, the ECB should act to favour this transition – provided that its intervention doesn't compromise the price stability. Put it in another way, if the ECB has the possibility to choose between two policy interventions, if both of them guarantee the price stability, the green policy must be preferred to the other one.
Secondly, climate risk has also an impact on an area under the direct supervision of the ECB: financial stability. Extreme climate events affect incomes and performances of families and businesses, possibly deteriorating their capacity of repaying debts. A surge in defaults related to projects exposed to various climate risks is likely to destabilise the whole system, given the typical way an initially concentrated shock propagates to the entire financial system. Additionally, climate change is asymmetric by nature. For instance, southern Europe is more exposed to heat waves while northern countries to heavy rains and floods. As a consequence even price stability suffers from climate change, since asymmetric shocks make the management of monetary policy more difficult, especially in the absence of a properly targeted fiscal response.
Whatever it takes
The ECB has saved the Eurozone by itself during the sovereign debt crises and for years it has been the major policymaker actively involved in stimulating the economy. After COVID-19 struck, the member states have finally agreed to introduce the fiscal policy lever by setting up the Recovery Plan – financed by European common debt. The European Green Deal has the ambition to make Europe the first zero emissions continent by 2050 and the member states are required to present credible plans to reach that goal.
Nonetheless, the commitment of the ECB can have a huge impact. Its role in saving the Euro is unanimously acknowledged and it has a reputation for getting things done. Addressing climate change is a monumental task. The ECB is right to add itself among the players fighting against it.
2021.10.04