This is the second of a two-part report, Responsible Investor looks at how the US central banking system is responding to climate change.
As noted in part one, the US Federal Reserve is operating in an unprecedented political environment, with President Trump constantly attacking it and its chair Jerome Powell.
“The US Fed has stopped innovating and is politically very much constrained,” says Eric Lonergan, a macro hedge-fund manager at M&G Investments, author and frequent commentator on central banking issues. “They can’t do anything useful and are very limited.”
This pressure comes as the system’s counterparts around the world are increasingly focusing on climate change risk, a topic the Trump Administration dismisses.
The Network for Greening the Financial System (NGFS) counts among its members some of the world’s most powerful central banks and regulators, bar the Fed and others like the Banco Central do Brasil.
Nevertheless, there is political pressure on the Fed to join the NGFS and address climate risk, coming from the likes of Presidential challengers Senators Bernie Sanders and Elizabeth Warren.
And Responsible Investor has spoken to staff within the Federal Reserve System who are investigating climate change risk.
Pressure from Washington
The Federal Reserve System has many layers. Most famously, the Fed’s Board of Governors, chaired by Powell, participate in the Federal Open Market Committee (FOMC), conducting monetary policy. The seven governors comprise the majority voting of the FOMC, with five other votes coming from the Federal Reserve Bank presidents.
The network of 12 Federal Reserve Banks, whose presidents rotate voting on the FOMC (except for permanent member, the New York Fed), act as operating arms of the Fed across the country, implementing monetary policy as decided by the FOMC and providing liquidity to banks in their areas. They also supervise the banks in their region and conduct economic research that informs national policymaking.
It is in the area of research that climate change risk is being explored by Federal Reserve Banks.
In March, the Federal Reserve Bank of San Francisco released a note on climate change that drew pressure from Washington, according to sources. The economic letter said climate change presents “relevant considerations for the Federal Reserve in fulfilling its mandate for macroeconomic and financial stability”. The research was also criticised by Libertarian groups.
Libertarian website Econlib, in a critical blog entitled “Ominous News”, said the San Francisco Fed wanted banks to get extra credit for making loans that help communities adapt to climate change and prepare for future national disasters.
In fact the paper, written by Glenn Rudebusch, executive vice president and senior policy advisor at the San Francisco Fed, who was also a member of the Federal Reserve Board of Governors in the 90s, cites the idea, among others, of central banks incentivising low-carbon lending. But Rudebusch says this is off the table for the Fed, saying: “Such ‘green’ quantitative easing is an option for some central banks but not for the Fed, which by law can only purchase government or government agency debt.”The San Francisco Fed is hosting a research event in November on climate change – believed to be a first in the US for central banks.
Fran Boait, executive director at think tank Positive Money, is not surprised that the San Francisco Fed is taking this lead. “You are seeing a hell of a lot of climate change in California. Wildfires destroyed Californian utility PG&E.” The fate of Pacific Gas & Electric, California’s largest utility, was widely described as the first “climate-change bankruptcy” when it collapsed in January.
Boait says the conversation in the US on climate change has generally focused on physical risk. “You see senators like [Hawaii Democrat Brian] Schatz pushing the agenda around physical risk and Powell talked about physical risk in his response to senators.”
The costs of climate change
Toan Phan, a researcher at the Federal Reserve Bank of Richmond, spoke to RI in a personal capacity about his research. “I’m personally involved in several ongoing projects,” he says. “Some with colleagues in the Richmond Fed and some with other colleagues including my friends and long-time co-authors Bridget Hoffmann at the Inter-American Development Bank and Ric Colacito at the University of North Carolina at Chapel Hill.”
“In general, our projects are trying to understand the effects of climate change on the two variables the Fed cares the most about. That is employment and financial stability.”
At the moment, Phan says he is investigating the effects of natural disasters with the IADB, a project he finds potentially exciting as it has a good data set. “This will include looking at, in particular, hurricanes, flooding, heat waves. The kinds of disasters whose intensity and, or frequency are predicted to increase due to global warming.”
Research published in the Journal of Money, Credit and Banking in 2019 that Phan conducted with Hoffmann and Colacito was cited by New Mexico Senator Martin Heinrich in his report Failing to address climate change threatens the economy.
The research was also mentioned by Berkeley economist Solomon Hsiang in a congressional testimony hearing on “The Costs of Climate Change: Risks to the U.S Economy and the Federal Budget.”
Commenting on the research, the Impact of Higher Temperatures on Economic Growth, co-author Colacito says: “We found that if you look at the average annual temperatures it is very hard to find any relationship between temperatures and economic activity but when you start to looking at specific seasonal temperatures, in particular summer temperature, the connection becomes more apparent.”
Phan from the Richmond Fed says other research he is conducting will look at exposure to flood risk and its effect on the financial market.
In his role Phan engages with policy makers at the Fed and he says he is impressed with the attention they give to research. “I was surprised with how much research is valued here,” he says.
He adds that the research director at the Richmond Fed believes that a major change in climate is underway. “He believes any responsible central bank has to know about this risk and proceed accordingly.”
The Chicago arm of the Fed is another that has been researching weather and climate. In 2015, senior economist and research advisor François Gourio and associate economist Justin Bloesch looked at the effect of winter weather on US economic activity.
Gourio says he is currently working on a paper looking at the cost of rising temperature for the economy. “What’s motivated this paper is to try and understand how each part of the US economy is sensitive to temperature. Basically the income in the south in the US is least sensitive to temperature. But a hot day in the north of the US is actually bad for income. It suggests that the south has adapted to hot days more than the north.”
Gourio says his paper on climate change, which is part of personal research within the Chicago Fed, will try to estimate why some regions may be more adapted to hot days and others not.
In January the Federal Reserve Bank of Minneapolis published an article summarizing past research entitled, Climate change: Uncertainty no excuse for inaction.
This month it ran an extensive interview with Robert Litterman, the economist and former head of risk management at Goldman Sachs who has turned his attention to climate change (see separate story in June, Robert S. Kaplan, President and CEO of the Federal Reserve Bank of Dallas, in a statement on economic conditions and the stance of monetary policy, said: “One factor we are increasingly discussing at the Dallas Fed is the impact of climate change. In particular, severe weather events can have a substantial human and economic cost to the district.”
He added: “As a central banker, I do not delve into the political and other controversial aspects of this subject. However, I do intently focus on the ways severe weather events and climate-related trends are likely impacting economic conditions and financial stability in the Eleventh District and the nation.”
But although individual Fed branches are starting to monitor the effects of climate change on the economy and financial stability, they are unlikely to join the NGFS independently of the Federal Reserve Board. “Typically the Federal Reserve System remains apart from things that might be described in one way or another as political or partisan or advocating or something that might end up in the political arena,” says a person close to the matter.