Central Banks & Climate Change: How Government Treasuries can Help or Hurt the Environment
By Anushka Bansal and Sahla Nawar, 6/24/2020
The Increasing Power of Central Banks
Developed countries such as England are usually described as free-market economies, where asset prices are controlled by the market forces of demand and supply. However, central banks in the present day have an increasingly significant influence on market price determination.
Following the global financial crisis of 2008-2009, central banks rushed to cut their benchmark interest rates close to zero in a desperate attempt to avoid an economic depression. The Bank of England rate was slashed to 0.5% in 2009, the lowest level in its history. Initially, the Bank of England was optimistic about raising interest rates. However plummeting oil prices, fears of a global economic slowdown, and the UK economic data caused the bank to wait for better conditions.
The growth forecast was cut to 1.3% in 2019 and in 2020. Dave Ramsden, the bank’s deputy governor, said that there might be good reasons why markets were optimistic about being able to ride out any difficulties, but said the experience of the financial crisis of 2007-09 showed that economies are not always as resilient as they appear.
In order to support economic activity and to avoid deflation, banks cut down their interest rates, which allows the banks to lend, and households and/or businesses to borrow. However, in the case of inflation, or an increase in cost of living, this can cause a “tightening in monetary policy.” Thus, the BoE is faced with the dilemma of keeping interest rates low, potentially worsening inflation, and keeping them high, dampening economic growth.
As new economic crises unfold, global economic improvements are becoming more competitive by the day. Decreasing profit margins, customer-oriented approach to service, and international banking regulations, put the banking sector in an important role in today’s highly competitive environment. Under the pressure of competition, the cost of financial services to potential users reduces. Therefore, the effect of central banks - especially the Bank of England (BoE), on which most modern central banks have been based - is more important now than ever.
Following the global financial crisis of 2008-2009, central banks rushed to cut their benchmark interest rates close to zero in a desperate attempt to avoid an economic depression. The Bank of England rate was slashed to 0.5% in 2009, the lowest level in its history. Initially, the Bank of England was optimistic about raising interest rates. However plummeting oil prices, fears of a global economic slowdown, and the UK economic data caused the bank to wait for better conditions.
The growth forecast was cut to 1.3% in 2019 and in 2020. Dave Ramsden, the bank’s deputy governor, said that there might be good reasons why markets were optimistic about being able to ride out any difficulties, but said the experience of the financial crisis of 2007-09 showed that economies are not always as resilient as they appear.
In order to support economic activity and to avoid deflation, banks cut down their interest rates, which allows the banks to lend, and households and/or businesses to borrow. However, in the case of inflation, or an increase in cost of living, this can cause a “tightening in monetary policy.” Thus, the BoE is faced with the dilemma of keeping interest rates low, potentially worsening inflation, and keeping them high, dampening economic growth.
As new economic crises unfold, global economic improvements are becoming more competitive by the day. Decreasing profit margins, customer-oriented approach to service, and international banking regulations, put the banking sector in an important role in today’s highly competitive environment. Under the pressure of competition, the cost of financial services to potential users reduces. Therefore, the effect of central banks - especially the Bank of England (BoE), on which most modern central banks have been based - is more important now than ever.
Green Potential: Central Banks & Environmental Policy
Among many institutions that influence the global economy, one of the most prominent one is the central bank of a country. Central banks are independent national authorities that control the monetary policy, regulate commercial banks, and provide financial services to the government. The central bank’s main aim is to implement the monetary policy and set the official interest rate, which is used to manage both the country’s inflation and the exchange rate. Monetary policy consists of the money supply and the rate of interest, these variables have direct impact on the aggregate demand of the country. On September 18, 2019, the U.S. Federal Reserve cut interest rates for the second time since 2008, recognizing muted inflation and concerns about global growth and trade uncertainty, especially the U.S.-China trade war.
The Federal Reserve cut its key lending rate to a range of 1.75% to 2.00% after a vote of 7-3. This played a crucial role in mitigating the impact this trade war held on the United States economy. The U.S. economy is a vital export market for various countries including Canada, Mexico, China, South Korea etc., representing nearly one-fourth of the global economy measured at market rates and a similar share of gross capital flows. Therefore, it is imperative for the Federal Reserve to be kept into consideration for international trade. It holds the potential to drastically shift the value of currency, thus impacting export value as well.
However, the impact of central banks extends the exchange of yen, peso and rupee. Central banks hold the potential to significantly impact a current and pressing issue: climate change. Climate change is a financial stability risk. Insurers could stand to lose millions from bushfires raging in Australia and other parts such as California. The spreading wildfires across countries threaten to further slow down economic growth, particularly in the tourism and consumer sectors, which could have a negative impact on consumer confidence. A huge number of jobs will also be gone, further resulting in unemployment. Water levels are rising at an alarming rate, banks could be at risk if mortgages in big port cities such as Guangzhou, Singapore, and New York end up flooded.
Central bankers should emphasize the interconnectedness of the economy and environment, while aiming to mitigate some of the effects through policy implementation. Governments could tackle this by implementing policy measures such as spending on decarbonization and electrification of the economy, although this will increase costs in the short run. In the longer run, it may result in various benefits including improved air quality, industrial revitalization and higher number of jobs. Looking from a micro perspective, it may help generate higher profits for firms who introduce it. Central banks should give importance to this as they can help make the financial system more sustainable. However, they must never drift from the core mandate.
As central banks are given more discretion in policy, as evidenced through central banks’ responses to the ongoing Coronavirus pandemic, these institutions have the power to create lending programs to banks that favor climate-friendly-oriented organizations, and are more willing to take risks in the name of environmental safety. Additionally, congress-mandated lending programs in the United States dealing with economic stimulus go through the central bank, giving the bank further discretionary authority on where the money should go. If central banks appropriate this money correctly, they could have long-term ability to affect stimulatory action towards climate-oriented organizations.
The Federal Reserve cut its key lending rate to a range of 1.75% to 2.00% after a vote of 7-3. This played a crucial role in mitigating the impact this trade war held on the United States economy. The U.S. economy is a vital export market for various countries including Canada, Mexico, China, South Korea etc., representing nearly one-fourth of the global economy measured at market rates and a similar share of gross capital flows. Therefore, it is imperative for the Federal Reserve to be kept into consideration for international trade. It holds the potential to drastically shift the value of currency, thus impacting export value as well.
However, the impact of central banks extends the exchange of yen, peso and rupee. Central banks hold the potential to significantly impact a current and pressing issue: climate change. Climate change is a financial stability risk. Insurers could stand to lose millions from bushfires raging in Australia and other parts such as California. The spreading wildfires across countries threaten to further slow down economic growth, particularly in the tourism and consumer sectors, which could have a negative impact on consumer confidence. A huge number of jobs will also be gone, further resulting in unemployment. Water levels are rising at an alarming rate, banks could be at risk if mortgages in big port cities such as Guangzhou, Singapore, and New York end up flooded.
Central bankers should emphasize the interconnectedness of the economy and environment, while aiming to mitigate some of the effects through policy implementation. Governments could tackle this by implementing policy measures such as spending on decarbonization and electrification of the economy, although this will increase costs in the short run. In the longer run, it may result in various benefits including improved air quality, industrial revitalization and higher number of jobs. Looking from a micro perspective, it may help generate higher profits for firms who introduce it. Central banks should give importance to this as they can help make the financial system more sustainable. However, they must never drift from the core mandate.
As central banks are given more discretion in policy, as evidenced through central banks’ responses to the ongoing Coronavirus pandemic, these institutions have the power to create lending programs to banks that favor climate-friendly-oriented organizations, and are more willing to take risks in the name of environmental safety. Additionally, congress-mandated lending programs in the United States dealing with economic stimulus go through the central bank, giving the bank further discretionary authority on where the money should go. If central banks appropriate this money correctly, they could have long-term ability to affect stimulatory action towards climate-oriented organizations.