Those sceptical that the European Central Bank (ECB) should green its monetary policy claim this is not compatible with the ECB’s mandate, and that this would be undemocratic. But fighting climate change is part of the ECB’s mandate, and democratically elected politicians can legitimise a greener approach.
Climate change will have a huge impact on our economy. This requires forward-looking action from all actors involved, including from central banks.
Central bank executives have largely come to this realisation already. For example, Bundesbank President Jens Weidmann has stated that central banks should “do more to combat climate change”. Only a few years ago, such a recognition of their own role in the fight against climate change seemed unthinkable. Today, the question of how the European Central Bank can contribute to addressing climate change is one of the most discussed issues.
Climate change and central banks
So what has happened in recent years? Put simply, increased awareness of the problem within central banks, as well as increasing pressure from civil society, has pushed climate change up the agenda. A significant impetus for this has come in the form of warnings about climate-related financial risks.
Certain industries are at risk of losing their financial value due to climate change – for example, because they are more exposed to climate-related physical damage or because they are pushed aside by the shift to a carbon-neutral economy. Led by prominent central bankers such as Mark Carney, a coalition of central banks and financial regulators formed to conduct research on climate-related financial risks, and develop approaches on how central banks could contribute to a climate-resilient financial system.
But one thing is clear about central banks’ efforts – it is not enough for them to simply ask financial actors to withdraw their investments from risky sectors, but not take action as central banks themselves. Currently, the ECB pays no attention to climate-related financial risks in its monetary policy measures, but blindly copies the financial market – climate risks included.
According to studies by Greenpeace and Positive Money Europe, the ECB’s €240 billion Corporate Sector Purchase Programme (CSPP) is largely targeted at carbon-intensive industries, whose financing costs are artificially reduced by the programme. In doing so, it not only amplifies climate-related financial risks but also exposes itself to them – a blatant contradiction of the ECB’s demands on financial actors to reduce such risks.
What could the ECB do instead? A lot. The bank could consider climate risks when selecting collateral for its future bond purchases. The ECB could also create incentives for banks and investors to invest in green projects (see the proposal of so-called “green TLTROs“).
The justification of a green monetary policy
However, two criticisms have been raised against this form of proactive green monetary policy. The first is a legal objection, according to which proactive green monetary policy is not compatible with the ECB’s mandate. The second is of a democratic-theoretical nature which states that, by adopting a proactive green monetary policy, the ECB would bypass the democratically elected parliaments and governments in their role as pacemakers of the green transformation.
The legal objection to a green monetary policy can be refuted relatively quickly. As recognised by the ECB itself, the ECB’s mandate includes two levels – the primary objective of price stability and the secondary objective of supporting overall EU economic policy.
A proactively green monetary policy is compatible and possibly even necessary to achieve both objectives. On the primary objective, a monetary policy instrument that supports green investment more directly could better support a return to an inflation path close to, but below, 2%. Such an approach could also help the ECB to achieve the price stability objective in the longer term. Finally, this form of monetary policy would reduce climate-related financial risks, thus also reducing the likelihood that the ECB will at some point no longer be able to meet its primary objective due to spiralling climate chaos – a possibility that has already been discussed by the Bank for International Settlements.
With regard to the secondary objective, it should be noted that EU-wide economic policy is already linked to climate objectives and to Article 3 of the EU Treaties. The latter states that economic policy shall aim at “a high level of protection and improvement of the environment”. Accordingly, a proactive green monetary policy would only take the secondary objective into account.
But contributing to the ECB’s Treaty objectives is not in itself sufficient to confirm the legitimacy of a proactive green monetary policy. For example, as the Federal Constitutional Court’s ruling in May showed, the legality of monetary policy decisions also requires an examination of proportionality. Accordingly, a measure can be disproportionate if it has side-effects that are not necessary to achieve the primary and secondary objectives. Among other things, this is intended to prevent the ECB from intervening in policy areas reserved for the nation-states by accepting too many side-effects. Should this be the case, the measure would be unlawful.
According to critics, this interference in national policy areas is present in the case of a green monetary policy. This form of monetary policy worsens the financing conditions of CO2-intensive companies, thus making central banks enter the field of sectoral industrial policy.
This argument can be countered by two brief points. First, the negative side-effects of a green monetary policy are not different in structure from the side-effects that CO2-intensive monetary policy already has today. In fact, the current monetary policy has the same effect in the opposite direction, because the financing conditions of CO2-intensive companies are improved. So anyone who criticises the side-effects of a green monetary policy as disproportionate but fails to mention the climate and environmental consequences of the current monetary policy is arguing inconsistently.
Second, the side-effects of a green monetary policy are probably more proportionate than the side-effects of the current CO2-intensive monetary policy. They at least do not counteract the ECB’s secondary objective. This is because the promotion of carbon-intensive industries runs counter to the EU’s economic policy, which is designed to protect the climate and the environment. Thus, the principle of proportionality is not only unsuitable to defend the status quo against a greener alternative, it would even prove that green monetary policy is preferable to the current version.
From legality to democratic legitimacy
Let us turn to the second point of criticism against a proactive green monetary policy – democratic legitimacy. In our view, there are two reasons why such action to green the ECB is already legitimate.
The first reason is the democratic support given by the European Parliament to a green monetary policy. From 2017, the Parliament has repeatedly adopted a series of resolutions supporting the ECB’s role in the fight against climate change. For example, a large majority, including most of the members of the conservative European People’s Party, approved a resolution to this effect last February.
The EP resolutions are not legally binding, but they clearly signal a political and democratic (!) endorsement of the central banks’ ongoing efforts to move in this direction. The same can be said of the European Council, which confirmed Lagarde’s appointment as ECB President, even after she very clearly stated in the parliamentary hearing her intention to “initiate a gradual transition towards the elimination of ‘carbon assets'” from the ECB’s portfolio.
The second reason relates to the Green Taxonomy, which removes the decisionmaking on which financial products are green away from the ECB. While this legislation was originally intended to serve as a basis for private investors, it is already used as a benchmark for EU institutions such as the European Investment Bank and in the EU’s economic recovery package.
As Lagarde has repeatedly stressed, the existence of the taxonomy would be “extremely useful” for the ECB, as it means that the ECB could use the EU taxonomy as an alternative benchmark for the principle of “market neutrality” to which the bank has so far adhered. In this way, the ECB would in no way be “leading” the fight against climate change – as is often feared – but would merely align its policies with the politically agreed upon framework that is gradually being put into practice by other EU institutions when using public funds.
The democratic pitfalls in the mandate
If there are still doubts about democratic legitimacy, these relate less to the features of green monetary policy per se, but instead reflect an unease with recent developments in central banking in general.
Although the ECB is constantly confronted with the side-effects of its policies, the mandate does not provide clear information on how to deal with them. This is because side-effects should not exist in the monetarist paradigm that significantly influenced the formulation of the mandate, or the ECB should never have to deal with them. This gap in the mandate, which legal scholar Nik de Boer and economist Jens van t’ Klooster call “democratic authorisation gaps“, has existed for some time. This gap resurfaced in the German Constitutional Court’s ruling in May, in which the court admonished the ECB for not weighing intended effects against non-intended side-effects. A proactively green monetary policy would only be the latest example which makes such a gap explicit.
Does this mean that we have no choice but to amend the EU Treaties to make ECB policy, including the option of proactively green monetary policy, more democratic? While treaty change would certainly be the ideal way forward, it is not a necessity. An alternative and probably more pragmatic way would be to define the secondary objective more clearly with the help of the European Parliament.
Since the ECB’s secondary objective is linked to Article 3 of the EU Treaties, which sets out several priorities that the EU’s economic policy should aim at, it is rather fuzzy. For not only is environmental protection to be found among these priorities, but also, for example, security and innovation. This makes it more difficult for the ECB to justify its policy according to its secondary objective, as this can mean many things – and possibly even contradictory things – at the same time.
A way out of this problem would be for the elected representatives in the European Parliament to vote on a ranking of the possible priorities mentioned in Article 3, possibly also in consultation with the European Council. This would clearly signal to the ECB which priorities are most relevant, which it should proactively support without compromising price stability over the medium term. If the European Parliament were to agree on a resolution that clearly ranked climate change mitigation as priority number one among the many items listed in Article 3, the ECB would no longer have to make such heavy use of its own discretionary powers.
As an independent institution, the ECB is of course not bound by what the European Parliament or the Council of the European Union tells it. But the resolutions would fill the above-mentioned “democratic authorisation gaps” in the mandate and thus provide the ECB with valuable democratic guidance. Or to put it another way – if parliaments explicitly signal that their central banks should do more for the climate, then the argument that green monetary policy bypasses parliament is null and void.
Recalibrating monetary policy from a climate and democratic perspective
Any discussion about the ECB today is complicated by the fact that its mandate was written three decades ago, when none of the current challenges were foreseen. It is therefore only natural that the ECB’s mandate today is subject to different and sometimes contradictory interpretations across the Eurozone. Criticism of a green monetary policy is therefore only natural and welcome.
Thankfully, central banks and political institutions such as the European Parliament have already created a majority for the position that central banks should ensure adequate consideration of climate risks in the financial market. However, whether central banks should go further in actively supporting the green transition remains a matter of policy debate and is not for central banks alone to resolve. It will depend on how much political legitimacy can be created for it.
This article was first published in German in Makronom.
(Image credit: Tree photo created by jcomp – www.freepik.com)