Every Avenue Available: Lessons from monetary history for tackling climate change

In a new study for the Sustainable Finance Lab (SFL), Rens van Tilburg and Aleksandar Simić analyze over 350 years of central banking history. They show that central banks have often helped governments to overcome economic hardships. It provides new arguments for a more proactive monetary policy when it comes to combatting climate change.

In response to the report, Klaas Knot, president of the Dutch central bank (DNB) and member of the Governing Council of the European Central Bank (ECB), emphasized:

“Climate change is a serious threat to global economic stability. As this report shows, periods of severe economic instability caused by climate change, can carry serious risks to financial and price stability. For that reason, in the medium to long term, a stable climate can be seen as an important precondition for central banks to be able to deliver on their mandate.”

SFL-chair professor Arnoud Boot:

“Central bankers have become dominant players in today’s economy. Too dominant in my view. With that influence comes the responsibility to use it wisely. Climate change is one of the defining challenges of our time. Whether they like it or not, central banks through their monetary operations influence the direction of the economy. They ought to make sure this influence is in line with governments policies like those aimed at mitigating climate change.”

Climate change can cause economic damage in the order of magnitude of the most disruptive wars. Central banks repeatedly had to reinterpret their mandates and use monetary policy as an instrument to help society tackle such challenges. These world wars were periods of high, or even hyperinflation. Analogous to times of war, climate change can cause high or even hyperinflation. Actively helping to prevent runaway climate change, can be seen as a precondition for price stability. This adds an argument for a more proactive stance to the current debate on monetary policy and climate change that is going on with the European Central Bank’s strategy review.

Moreover, the authors argue that central banks are uniquely positioned to contribute to mitigating climate change, because of their long history of international cooperation, closely aligned mandates and much longer tenures than their respective governments. As history shows, central banks have often played a pivotal role in financing economic developments of a scale and time span similar to that of mitigating climate change. Monetary support for reconstruction and industrialization development, like ‘the New Deal’ and the aftermath of World War II, did not lead to excessive inflation.

In response to the recent economic crisis, central banks have adopted new forms of unconventional monetary policy. Van Tilburg and Simic propose that such unconventional policy could specifically support investments in the global energy transition. In support of government policies, monetary policymakers should therefore formulate a common long-term global strategy to fight climate change. Thus central bankers would act in line with what Christine Lagarde, president of the European Central Bank, promised to do with the ongoing ECB strategy review: “to explore every avenue available in order to combat climate change”.[1]

The full report can be found below.

[1] Khalaf, R., & Arnold, M. (2020). Lagarde puts green policy top of agenda in ECB bond buying. Financial Times, July 8 2020.