Central banks review monetary policy for climate weaknesses

Climate change is already affecting economic activity in both emerging and advanced economies, say the banks.

Significant numbers of central banks expect climate change to impact the effectiveness of monetary policy operations, according to a new survey of members of the Network for Greening the Financial System (NGFS).

Around two-thirds of 55 central bank respondents agreed that the climate will influence monetary policy operations, while 75 percent said monetary policymakers will have to account for trade-offs when devising their programmes.

It comes amid growing concerns around central banks’ involvement in climate initiatives, particularly in the US. Earlier this year, Federal Reserve chair Jay Powell said: “It would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals.

“We are not, and will not be, a ‘climate policymaker’.”

Monetary policy is the main tool used by central banks to support price stability, and works by adjusting the amount of money in an economy and interest rates.

But despite the outsize effects of climate change on the economy, there is little understanding of how the physical and transition risks of climate change could limit or skew the effectiveness of monetary policy conduct.

The NGFS survey – which contained responses from two-thirds of the NGFS membership – has been described as “the most extensive review of central bank thinking ever undertaken on climate change and monetary policy” by Bank of England climate adviser Michelle Van Der Merwe, part of the project team who compiled the results.

It follows earlier scoping exercises by the NGFS on monetary policy and on the tools available to adapt climate factors into monetary policy in 2020 and 2021 respectively.

As of today, around 40 percent of respondents said they have already integrated climate change considerations into economic models used to develop monetary policy and are considering further steps, in particular to protect their own investment portfolios from climate-related financial risks.

Close to half of respondents, around 47 percent, have carried out exercises to better understand how the physical impacts of climate change will materialise as macroeconomic effects. Similar numbers of central banks from emerging and advanced economies said that physical impacts had already impacted their economies.

Meanwhile, 43 percent of respondents said they have assessed the macroeconomic effects of transition risks, and around one-third said transition risks could lead to an improvement in productivity due to investments in technology and education.

However, the survey noted that a lack of resources, expertise and data within central banks represented significant obstacles to progress understanding on this topic.

The survey was conducted between July and September 2022, with feedback from 55 out of 88 NGFS members. There was equal representation between advanced and emerging economies.

The European Central Bank, an NGFS member, has already made a number of high-profile moves to integrate climate considerations within its monetary policy operations, including the introduction of a green tilt to corporate bond purchases and restricting the share of high-carbon assets it will accept as collateral for bank lending.

The NGFS’s monetary policy workstream, which has a mandate until June 2024 under the Bank of England’s chairship, aims to provide a platform for NGFS members to discuss how to adjust their economic models to account for climate risks. It has not announced a follow-up initiative to the survey.