The Federal Reserve Takes Climate Change Seriously

(Bloomberg Opinion) -- Activists have been preparing to send a message at this week’s (now virtual) annual gathering of central bankers in Jackson Hole, Wyoming: U.S. Federal Reserve Chair Jay Powell, arguably the world’s most powerful financial official, isn’t doing enough to address the threat of climate change — and, for this reason, shouldn’t be reappointed to a second term.

I disagree. Powell’s actions demonstrate that he takes the phenomenon seriously. He’s doing the best he can, given the constraints he faces.

There are two main areas where the central bank must grapple with global warming: financial supervision and monetary policy. Officials are fully engaged on the first. They know the risks well. More volatile weather — including hurricanes, wildfires and extreme drought – can damage homes and businesses, impairing their owners’ creditworthiness and precipitating losses for banks. Rising sea levels can reduce lenders’ diversification, by threatening waterfront properties everywhere. The prospect of more frequent natural disasters and regulatory action can reduce the value of collateral backing loans, be it a coal-fired power plant or a beachfront condominium.

Powell and the Fed’s Board of Governors created two new entities — the Financial Stability Climate Committee, to focus on the broader financial system, and the Supervision Climate Committee, to focus on individual institutions. This matters, because it means top officials are committed to regularly evaluating and responding to the threat. They’re already working to ensure that banks embed climate change in their business decisions - analyzing exposures, identifying concentrations of risk and considering how to manage them over time. To that end, the Fed and other bank regulators will make banks gather information in a consistent way.  Such information is needed so that regulators can enforce a consistent set of standards and evaluate and manage risks across the entire system.

On monetary policy, Powell has been less aggressive, noting recently that it’s “not something we directly consider” in deciding, for example, where to set short-term interest rates. This stands in contrast to other institutions such as the European Central Bank, where climate change is part of monetary policy deliberations.   

Why the difference? I see a couple explanations. For one, climate change is a slow-moving secular trend, unlike the cyclical trends in supply and demand that dominate the near-term economic outlook and are hence most relevant for monetary policy, which tends to have a horizon of a few years or less. So even if one takes it seriously, as the Fed does, it’s not clear how that would translate into, say, adjustments to the Fed’s asset purchase program or the trajectory for short-term interest rates.

Beyond that, Powell faces a unique political constraint. In the U.S., the left and the right disagree far more vehemently on the importance of climate change than they do in Europe. It’s one thing for the Fed to consider climate in overseeing the financial system — nobody wants another crisis. But if the central bank explicitly included climate as a monetary-policy consideration, some lawmakers could accuse it of overstepping its dual mandate of ensuring maximum sustainable employment and price stability. This, in turn, could result in limits on the independence the Fed needs to conduct its policy responsibly.

Critics are undoubtedly unhappy that the Fed isn’t doing more, but they should recognize the constraints under which the Fed operates. Officials recognize that climate change poses a threat to the U.S. and global economy. But they must tread carefully, so they can maintain the powers they need to mitigate the risks.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Bill Dudley is a Bloomberg Opinion columnist. He is a senior research scholar at Princeton University’s Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. He was previously chief U.S. economist at Goldman Sachs.

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