With British inflation clocking in at 10.1 percent, or over five times the level targeted by the Bank of England, criticisms of the central bank’s remit to support “net zero” climate goals have been coming in thick and fast, as Bloomberg reported on Tuesday. The article was headlined: “Scrap Bank of England’s Climate Mandate, Balls and Osborne say.”
One of the key architects of UK central bank independence, Ed Balls – an adviser to former Chancellor of the Exchequer Gordon Brown when the Labour Party made the bank independent in 1997 – said it “doesn’t make any sense” to give the BOE a role for which it has no tools. “It concerns me, the idea that you start to throw into the mix objectives which aren’t really affected sensibly by the instrument the bank has – which is interest rates.” Bloomberg also reported that Paul Tucker, a former BOE deputy governor, and John Vickers, a former BOE chief economist, suggested that net zero has been a distraction.
Mr. Balls was speaking at the House of Lords’ economic affairs committee inquiry into the independence of the BOE on Tuesday. At the meeting, ex-Conservative Chancellor George Osborne agreed with Balls. Both were of the view that climate goals should be stripped from the Bank of England’s remit to remove any distractions from its focus on inflation and financial stability. Failing to prevent double-digit inflation, critics argue that the bank should not distracted by such policy “baubles.”
Central Banks: What Happened To Taking The Punchbowl Away?
The world’s central banks have historically operated under narrow mandates to safeguard financial stability by overseeing the financial system of private and public-sector banks and managing liquidity and interest rates. One has the rather droll image of central bankers as those whose job was to “take away the punch bowl just when the party gets going’”. The narrow mandate for central banks was to avert financial crisis and achieve price stability by utilizing its tools of credit creation and interest rate guidance.
In recent years, however, central banks as well as multilateral financial institutions such as the World Bank and the IMF are increasingly involved in efforts to enhance the role of “stakeholder capitalism” in capital markets. With the US, EU and UK push to “fight climate change”, there has been much discussion on the role of central banks in addressing risks associated with climate change and in supporting the development of green finance.
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Reflecting this development, Mark Carney, the previous Governor of the Bank of England was appointed UN special envoy for climate action and finance in 2020 to galvanize action among financial institutions in the lead up to the global climate talks due to take place in Glasgow in November 2021. The appointment of Mark Carney as UN special envoy reflects efforts in the EU to link central banks and multilateral development banks and financial institutions directly to ESG (environmental, social and governance criteria) and “green finance”.
Multilateral financial institutions such as the World Bank, the Asian Development Bank, the European Investment Bank and the International Monetary Fund are increasingly involved in efforts to enhance the role of ESG and “stakeholder capitalism” in capital markets. They have either already stopped, or plan to end soon, the funding of fossil fuel-based projects. The IMF – originally established to further international monetary cooperation, safeguard global financial stability and encourage the expansion of trade and economic growth — supports the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) to promote the climate agenda promoted by the EU and the US. The Biden administration’s Secretary of the Treasury Janet Yellen plans to push lenders to adopt "green" lending policies. According to Yellen, the US federal government will “need to seriously look at assessing the risk to the financial system from climate change”.
The US Federal Reserve recently joined the NGFS to mobilize mainstream finance for the transition toward a “sustainable” economy and to share and identify best practices in the supervision of climate-related risks. According to the 2020 Financial Stability Report, the Federal Reserve will:
“monitor and assess the financial system for vulnerabilities related to climate change through its financial stability framework. Moreover, Federal Reserve supervisors expect banks to have systems in place that appropriately identify, measure, control and monitor all of their material risks, which for many banks are likely to extend to climate risks.”
European Central Bank (ECB) President Christine Lagarde said that she wants “to look at all the business lines and the operations in which we are engaged in order to tackle climate change.” The ECB will now pursue policies to favour European banks and private sector companies to fund “green” projects. The ECB will start accepting bonds linked to “sustainability” goals as part of the Ms. Lagarde’s drive to press ahead with the green agenda. Similarly, Governor Andrew Bailey suggested in 2021 that the Bank of England might also weigh green concerns more heavily in its corporate-bond portfolio.
The definitions of “green” and “sustainability” remain to be operationalized with clear metrics. There were some 70 different ESG rating agencies and 600 ESG ratings by 2020. Perhaps the most confounding feature of assessing ESG investments relates to the vague and amorphous character of “social equity”, “environmental justice” and “sustainability” concepts. There is no single, universally agreed upon list of what factors to consider when looking into the ESG commitments of a given corporate entity.
Risky Move By Bank Regulators
Beyond the traditional objectives of price stability and avoiding financial crises, should governments support a vastly expanded remit for their central banks? Should financial regulators arrogate climate change tasks among their functions? The move by regulators such as the US Federal Reserve and the Securities and Exchange Commission to incorporate “green finance” poses key risks. By allowing regulations to tilt the financial playing field in favor of business deemed “green” and “sustainable”, whatever they might mean, the impartiality of financial regulators towards different regions, sectors and industries across an economy is fatally compromised. In noting this dangerous ‘mission creep’ of central banks, Professor John Cochrane in a recent testimony to the US Senate Committee on Banking, Housing and Urban Affairs warned that the boardrooms of central banks and securities regulators risk becoming politicized.
By straying from its core mission and authority in financial regulations to support climate goals which are based on contentious, uncertain and highly complex climate science models, a financial regulator’s actions will undermine its credibility and betray its independence. When unelected governors and financial agency heads engage in climate policy, it is an invitation for special interests to encroach into the heart of the financial system and degrade its ability to fulfil their legitimate role to ensure sound money, stem financial crises and ensure competition and transparency in the financial and securities sectors.
Climate policy is beyond the scope of any financial regulator’s expertise. Given the uncertainty within the climate science community itself, there is no reason to believe that they can have any greater understanding of climate risks. Government appointed finance bureaucrats are surely not competent in adjudicating the enormous uncertainties and complexities underlying climate models. Financial regulators have no experience or expertise in environmental policy. The considerable power of the financial authorities over investment decisions and corporate behaviour risks the politicization of the capital allocation process and fundamentally undermine the efficiency of capital markets. This would undermine the very engine of market capitalism itself.
A country’s response to climate change is more properly decided by elected leaders who would enact policies through a consultative legislative process after having engaged with specialized environmental and scientific agencies. Climate science, we need to be reminded, is not “settled”. Given the global nature of adapting to climate change, international negotiations would be part of that process. And to avoid an ideologically inspired “consensus” in science, elected leaders would be well advised to have a “red team-blue team” approach to getting scientific evidence marshalled if legislative remedies are called for.
The argument that climate change presents systemic risks to the financial system is implausible. Systemic financial crises occur when the banking system as a whole loses its reserve margins and capital in short order, leading to a run on its short-term debt. There is no shortage of real systemic risks with unsustainable debt, accelerating inflation, collapse in international trust on the US dollar — a fiat currency – as a reserve currency for international transactions, and a global sovereign debt crisis when the US government runs out of borrowing capacity.
One could add other possible non-economic shocks that can lead to catastrophic outcomes to the financial system which have nothing to do with the climate: bioterrorism causing infection fatality rates of 10% or more rather than the covid pandemic’s estimated rates within the 0.15 – 0.20% range, massive cyberattacks that disable national grids and IT infrastructure, or escalation of wars into tactical, then theatre, nuclear attacks by a series of mistakes or perceived provocations.
The Real Systemic Climate Risk Is Climate Policy
Extreme weather – floods, hurricanes, heat waves, cold snaps – present no systemic risk and are well handled by insurance markets and adaptive measures such as dykes, drainage systems, robust construction technologies and the like. Over the past century, with economic growth and modern technologies, deaths from extreme weather events has dropped by 96% globally. Indeed, the only real systemic risk related to climate is likely not from “climate change” that occurs with great natural variation over time and space but from the very climate policy responses to the hobgoblins of our own making.
It will not be the first time that great nations fulfil apocalyptic prophecies of their own making. Let us not allow central bankers to be lead players in all of this.
