A Role for Financial and Monetary Policies in Climate Change Mitigation
IMF Blog, September 4, 2019
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Bibliographic details
- Authors: William Oman
- Published: September 4, 2019
Overview
- July 2019 was the hottest month ever recorded on earth.
- A prolonged drought is affecting millions of people in East Africa.
- In August 2019 Greenland lost 12.5 billion tons of ice in one day.
- A review of the literature by IMF staff aims to spur discussion of what policies to mitigate climate change could or should include.
- The review suggests that, while fiscal tools are first in line, they need to be complemented by financial policy tools such as financial regulation, financial governance, and policies to enhance financial infrastructure and markets, and by monetary policy.
- Financial and monetary policy tools can complement fiscal policies and help with mitigation efforts.
Stakes and mitigation targets
- There is a broad scientific consensus that achieving sufficient mitigation requires an unprecedented transition to a low-carbon economy.
- Limiting global warming to well below 2 degrees Celsius requires reductions of 45 percent in CO2 emissions by 2030, and reaching net zero by 2050.
- Despite the 2015 Paris Agreement, greenhouse gas emissions are high and rising, fossil fuels continue to dominate the global energy mix, and the price of carbon remains defiantly low.
Case for policy action beyond carbon pricing
- Current incentives are insufficient to encourage investment in green private productive capacity, infrastructure, and R&D.
- Investments continue to pour into carbon-intensive activities, preventing needed decarbonization of the global economy.
- Decarbonization requires a transformation in the underlying structure of financial assets; studies suggest this transformation is hindered by deficiencies in market functioning.
Market deficiencies identified in the literature
- Financial risks may not reflect climate risks or the long-term benefits of mitigation, given many investors’ shorter-term perspectives.
- Financial risk assessments often fail to capture climate risks, which are complex, opaque, and have no historical precedents.
- There is a wide gap between the private profitability and the social value of low-carbon investments.
- High uncertainty around low-carbon investments’ ability to reduce emissions, and uncertainty about the future value of avoided emissions, makes such investments unattractive in the short run.
- Corporate governance that favors short-term financial performance may amplify financial “short-termism.”
- Constraints in capital markets can lead to credit rationing for low-carbon projects.
Policy tools suggested by studies
- Policies are divided into two categories: climate risk-focused and climate finance-promoting.
- Climate risk-focused tools (aim to correct lack of accounting for climate risks and change demand/prices for green vs. carbon-intensive investments):
- Monetary policy examples:
- Developing central banks’ own climate risk assessments.
- Ensuring climate risks are appropriately reflected in central banks’ collateral frameworks and asset portfolios.
- Financial policy examples:
- Reserve, liquidity and capital requirements.
- Loan-to-value ratios.
- Caps on credit growth.
- Climate-related stress tests.
- Disclosure requirements and financial data dissemination to enhance climate risk assessments.
- Corporate governance reforms.
- Better categorization of green assets by developing a standardized taxonomy.
- Climate finance-promoting policies (seek to account for externalities and co-benefits of mitigation and to shift relative prices and increase investments; these add new goals to existing policies and are more controversial):
- Monetary instruments:
- Better access to central bank funding schemes for banks that invest in low-carbon projects.
- Central bank purchases of low-carbon bonds issued by development banks.
- Credit allocation operations.
- Adapting monetary policy frameworks.
- Financial policy instruments:
- “Green supporting” and “brown penalizing” factors in banks’ capital requirements.
- International requirements of a minimum amount of green assets on banks’ balance sheets.
Key takeaways and recommendations
- Financial and monetary policies can play a key role because they directly influence the behavior of financial institutions and the financial system.
- More work is needed: the literature remains limited on the desirable package of measures to address climate mitigation.
- Financial and monetary policy tools can complement fiscal policies and help with mitigation efforts.
- As Mark Carney of the Bank of England warned, “the task is large, the window of opportunity is short, and the stakes are existential.”
Source: A Role for Financial and Monetary Policies in Climate Change Mitigation (IMF blog, William Oman, September 4, 2019).
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