[The original version of this text can be found here]
So much noise and controversy surrounded Cop28 that it was easy to miss what may have been the most significant development. French president Emmanuel Macron used his speech at the UN climate conference to, among other things, endorse the idea of dual interest rates; in other words, a favourable interest rate on loans for green, as opposed to dirty, projects.
It is, he said, “absurd” that private finance has no incentive to finance renewable energy over coal projects. It is indeed absurd that companies developing wind and solar installations, so vital for the net-zero transition, are charged the same interest rates as those for fossil fuel projects.
The case for dual interest rates has been made by policy experts and academics for several years, so Macron’s backing was a welcome surprise. Political support from a European head of state is especially welcome considering the vehement arguments made by the European Central Bank (ECB) against adopting differentiated rates in the current inflationary context.
Yet those arguments seem to be political and ideological rather than economic – it is precisely by investing in renewables and energy efficiency that we will protect ourselves against future inflation caused by volatile fossil fuel prices. Furthermore, achieving net zero necessitates substantial investments beyond the scope of public finance, urging an immediate redirection of private funds to bridge the financial gap.
Dual interest rates are possible
A quick survey of recent history is enough to dismantle the arguments that dual rates are not possible, even in an inflationary context. After the financial crisis and during the Covid-19 pandemic, the ECB offered a lower interest rate to banks compared to its standard credit operations under the targeted longer-term refinancing operations (TLTRO) programme, on the condition that banks would continue lending to the real economy. This created a dual interest rate system.
TLTROs increased the volume of lending by improving the terms on which non-financial corporations and households could borrow. However, as evidenced by a recent study, there was a carbon bias in the third TLTRO programme which led to increased lending to higher-than-average carbon-emitting sectors.
Since 2020, academics and civil society have been calling for a green TLTRO – by tweaking the existing programme, the ECB could create incentives for private banks to lend more money for green investments. Several members of the ECB’s executive board – including ECB president Christine Lagarde, along with Isabel Schabel and Frank Elderson – have spoken in favour of adopting tools that would target lending towards green activities.
Yet the ECB’s official line is that it will not do so in the current economic context as increasing the volume of lending to the economy would be inconsistent with fighting inflation. To this end, the ECB changed the favourable financing conditions under its existing TLTRO III programme in November 2022.
Because of high inflation caused by supply-side bottlenecks and the energy crisis following Russia’s invasion of Ukraine, the ECB has been insistent on raising interest rates and doing nothing else.
The irony of this approach is two-fold. First, loan rates are increased for people wanting to renovate their energy-inefficient homes, the very same homes consuming the fossil fuel energy that has been spurring inflation. Second, by increasing interest rates, the ECB is also increasing financing costs for renewables. As a result, high interest rates are harming the very investments in renewable energy that are needed to avoid future inflation driven by fossil fuel prices.
The argument against adopting dual rates for green activities is therefore ideological and political, especially since exceptions have been made in the past for sectors that have proven to be inflation reducing, such as exports.
Dual interest rates are necessary
Dual rates are necessary to close the net-zero transition investment gap. The green transition demands a substantial increase in investment. The European Commission has estimated that €620bn will be needed annually, equivalent to 3.7% of GDP in 2022. According to the European Investment Bank, about 45% of this is expected to come from government finances.
Fiscal policy will have to play a pivotal role by ramping up public investment and mobilising private capital to support the green transition. However, the current tightening of monetary policy by the ECB threatens to constrain the fiscal space needed for these investments by increasing the burden of interest payments faced by European countries. The higher interest rate environment, along with the constraints on public debt imposed by new EU fiscal rules, leaves less room for governments to invest in the green transition.
This state of affairs favours investment in fossil fuels, rather than renewable energy. The upfront costs associated with wind and solar projects makes them more exposed to higher interest rates. The International Renewable Energy Agency estimates that if the total cost of capital for renewable energy is 10% then the total energy cost increases by 80%, compared to a 2% capital cost. The bulk of fossil fuel costs, however, are in maintaining the constant inflow of coal, gas and oil so the initial capital required is relatively lower.
Reducing interest rates would lower upfront costs and increase the competitiveness of renewable energy sources, and therefore boost investment. In addition, ensuring the interest rate stays low for the medium- to long-term would reduce the uncertainty faced by renewable energy companies when undertaking their long-lived investments, further encouraging investments in those sectors.
Dual interest rates would ensure that finance keeps flowing towards much-needed green investments without increasing country deficits, and we can see how this works in practice. In 2009, the French government launched an interest-free loan for domestic energy efficiency improvements, known as éco-PTZ, in which the interest cost is subsidised by the state.
One of the main problems with the policy is that it is simply not sustainable in the long run in terms of government budget, especially considering the size of the renovation challenge. If the central bank subsidised these loans instead, then public money and people’s taxes would not need to be touched.
In a letter to a group of policy experts on the subject of green TLTROs, Lagarde suggested that a potential technical obstacle to the adoption of dual rates could be data gaps. However, targeted lending for energy-efficient renovations will be possible due to the upcoming implementation of the EU’s green taxonomy and Pillar 3 ESG disclosure requirements. From June 2024, all banks are required to report on the volume of their renovation loans and this data could be used by the ECB to adopt a dual rate.
Political endorsement for dual rates
Macron’s endorsement of a general dual-rate policy – which he reiterated in a recent article for Le Monde – was a welcome gesture for the many civil society organisations and academics that have long championed integrating climate considerations into monetary, prudential and fiscal policy. However, the adoption of dual rates by any institution needs to come with sufficient democratic safeguards.
In the case of the adoption of dual rates by the ECB, this means strong oversight from the European parliament and a clear alignment with the environmental objectives of the EU. The ECB is, above all, a technocratic institution that is independent of government. It is therefore vulnerable to criticism about its lack of democratic legitimacy if it takes bold action on climate without political endorsement and oversight.
For this reason, France should actively push for the adoption of this policy at the EU political level, which would leave the ECB with no excuses against adopting it.