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The Fed Led the World Out of 2008. On Climate, It’s a Follower

What’s keeping the world’s most powerful central bank from being a trailblazer? In a word, politics, according to historian Tooze.

The Fed Led the World Out of 2008. On Climate, It’s a Follower
An injured kangaroo stands in a paddock near Nowra, New South Wales, Australia. (Photographer: David Gray/Bloomberg)  

(Bloomberg) -- When bad things happen to economies, or threaten to, the world has gotten used to seeing central banks at the front line of defense — with America’s Federal Reserve in the lead.

That’s not how the climate crisis, potentially the biggest economic threat of all, is playing out. Some central bankers have spent years examining risks, and now they’re finding ways to act. At the Fed, the conversation is just getting started.

The Fed Led the World Out of 2008. On Climate, It’s a Follower

The costs of climate change are already piling up. They’re forecast to get much worse — and the problem goes far beyond episodes of wild weather. Central banks are grappling with how a warming climate will upend calculations about everything from prices to the productivity of workers — areas that fall right into the mandate of central banks.

But the Fed didn’t hold a major conference on the topic until a couple of months ago, and it’s stayed away as peers set up a global network to promote climate-friendly finance. Green monetary policy seems likely to get tested outside America first — unlike many innovations that emerged from the 2008 crash.

What’s keeping the world’s most powerful central bank from being a trailblazer? In a word, politics, according to historian Adam Tooze at Columbia University. His 2018 book “Crashed” cast new light on the Fed’s global leadership a decade earlier. He says it’s uniquely ill-placed to play a similar role on climate.

Fed officials are already getting harangued by President Donald Trump over interest rates — their home turf. If they’re seen to be straying outside their mandate of price stability and full employment, pressure from a climate-skeptical administration could intensify.

“Other countries don’t have politics in which the issue of climate has been divisive since the 90s,” said Tooze. Fed officials “would be putting themselves in danger if they address this right now.”

That’s one reason Chairman Jerome Powell and colleagues are content for now to watch what other central banks are doing.

The banks have three sets of tools that could help fight climate change. They influence the cost of credit with monetary policy. Wearing their regulator hat, they set rules for lenders. And their armies of economists can chart a course for research.

Green QE?

Interest rates are a blunt tool, but another kind of monetary policy that’s caught on in the past decade — the large-scale purchase of financial assets, known as Quantitative Easing — holds more green promise.

Christine Lagarde, the European Central Bank president, has floated the idea of doing “green QE.” As the bank acquires corporate bonds, the idea goes, it can speed the transition to a low-carbon economy by excluding polluters and only buying the debt of clean companies — who’ll thus enjoy lower borrowing costs.

That would be a departure for the ECB, whose bond-buying has so far been “market neutral” — reflecting the economy as it is, rather than trying to tilt it in a green direction.

That task, say critics like Germany’s Bundesbank chief Jens Weidmann, is best left to elected politicians — an argument Fed officials use too, and one that highlights important limits for Western-style central banks. They’re supposed to stay walled-off from any political agenda. It was concern about overstepping those boundaries that has so far kept the Fed from joining the global network of green central banks.

The Fed Led the World Out of 2008. On Climate, It’s a Follower

One example of a radically different system is China, whose central bank makes no claim to be independent. Instead, it works with the government to channel credit into chosen industries. That includes green finance, where China’s a world leader.

Western economists are starting to question the hardline version of central-bank independence. Paul De Grauwe at the London School of Economics says there’s no reason the ECB can’t use its money-creating powers to directly fund environmental investment.

While that’s a remote prospect, Green QE is at least on Europe’s radar. It couldn’t be done in the U.S. under current rules, which bar the Fed from buying any corporate bonds, however green they are.

Climate Stress

On regulation, the Bank of England under outgoing chief Mark Carney has taken the lead.

Starting next year, U.K. banks and insurers will undergo “stress tests” to show they can withstand direct shocks from climate change, and indirect ones from policy in the event of a government decision to abandon fossil fuels.

The idea was echoed approvingly by Mary Daly, head of the San Francisco Fed, at the November climate conference.

“Ensuring financial institutions are regularly evaluating their exposure to climate-related risks is an increasingly important part of our work,” said Daly, whose district was ravaged by wildfires last year.

But it’s officials at Fed central, not the regional chiefs, who are in charge of regulation. Powell and Lael Brainard, who chairs the committee on financial stability, have generally sounded more cautious — although Brainard, at the conference, said the Fed supports efforts “to improve standardization of financial disclosures related to climate change.”

Top-Down Research

When it comes to research on how climate hurts economies, the Fed’s already on the case — and there’s more to come, according to Robert Kaplan, chief of the Dallas Fed.

Gulf-coast energy producers in his district have taken a hit from extreme weather. “We think this will increasingly start to manifest itself in affecting GDP,” Kaplan said last month. “That’s a lot of the work that we’re doing.”

The Fed is among the world’s biggest employers of economists. But its research agenda tends to emerge organically, driven by what staffers think is important or interesting.

The Bank of Canada takes a more top-down approach. Its analysts have been tasked with examining everything from risks for Canadian energy companies if their carbon assets get “stranded,” to how climate change might affect global productivity and interest rates.

‘Speak My Mind’

For the Fed to wade deeper into the climate fight on any of these fronts — monetary policy, regulation or research — may entail taking a political risk.

But climate change is already impacting areas where the Fed has a direct mandate, according to Peter Conti-Brown, an assistant professor at The Wharton School, who’s written a history of the central bank. His conclusion: “The Fed can’t avoid this.”

“There are instances throughout history when central bankers decided: ‘I’m not playing political games. I’m going to speak my mind’,” Conti-Brown said. “I would put high probability on seeing a significant climate-change declaration in the next two years. It may also coincide with a new administration.”

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To contact the editor responsible for this story: Margaret Collins "Peggy" at mcollins45@bloomberg.net, Ben Holland

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