Central bankers in climate change policy teams: Good or bad?

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Amol Agrawal

Last December, the UK (United Kingdom) government announced Andrew Bailey as the replacement for Mark Carney as Governor of the Bank of England. What was even more interesting was the government’s announcement over the next role for Carney.

The UK Prime Minister appointed Carney “Finance Adviser for COP26 (UN Climate Change Conference of Parties number 26) to help build a sustainable financial system to support the transition to a net zero economy”. The central bankers are often appointed to build sustainable monetary and financial systems, but this appointment has an extra role of reorienting the financial system to support the transition to a net zero emission economy.

Having said that, if a central banker had to be appointed for this task, there is no better person than Carney as he has really led from the front on climate change policies. He has given several speeches pointing to how central banks can play a role in making the economy less carbonized and lower emissions.

Taking a cue, there is a growing herd of central bankers all across the world who are waking up and speaking on the challenges climate will play on their respective economies. Streams of articles are being written on whether and how central banks can play a role in building a less carbon economy (Please read my earlier piece).

Some might think that concepts like climate change are very different and central banks should stay away. There is no doubt that climate change requires one to understand several other concepts or subjects and most of them do not resemble issues of monetary economics and finance. However, I would argue that central banks might find the territory familiar and could contribute something to the debate.

For a while, climate change talks had been meandering with confusing goals. This changed with the Paris accord where the signee countries were given a numeric goal. The goal was “Holding the increase in global average temperature to well below 2° Celsius above pre-industrial levels; and to pursue efforts to limit the increase to 1.5° C. If the increase was pegged to 1.5° C, it would significantly reduce the risks and impacts of climate change”.

This climate change goal might not really mean much to others, but will sound music to a student of central banking. Thirty years ago, central banks across the world over were struggling with the ghost of inflation. They had tried monetary targets based on prescription of economist Milton Friedman, but those were not really working. In the words of Gerald Bouey (1973-87), the then Governor of Bank of Canada, “we did not abandon monetary targets, they abandoned us”.

Just when search for a reliable monetary anchor looked elusive, emerged a bright idea in the unlikeliest of the economies, which is New Zealand. The Reserve Bank of New Zealand turned the problem upside down and began targeting an inflation rate and used interest rates as an instrument to target inflation. The approach began to be famously known as inflation targeting and soon became the gold standard across central banks. It is incredible how several countries began to target inflation in the next 30 years and were really successful to bring down inflation levels.

Having said that, the credit for bringing inflation lower does not purely go to inflation targeting as other factors were also important. But inflation targeting brought the change in thinking which was missing from the profession (Please see my piece on 30 years of inflation targeting).

So much so, the problem has reversed in the next 30 years with most developed world struggling with low inflation. The economists do cite that central banks keeping inflationary expectations anchored has been one of the main reasons for the low inflation. Talk about a success becoming a limitation soon!

In a way, the approach to defining climate change in terms of a temperature target is quite similar to defining price stability in term of an inflation target. Apart from the numeric similarity, which is a mere coincidence, such targets provide a clear well-defined goal for the policymakers. A target helps holding authorities accountable for the tasks. These reasons which are ascribed to having an inflation target apply to having a climate target as well.

Having said that, there are obvious differences. Tacking climate change is much trickier compared to price stability and many instruments will be needed to achieve the objectives. Climate change also brings the typical externality element which requires global cooperation. It also runs for a much longer term than monetary policy outcome.

Given this brief, central bankers being part of climate change exercises can bring some more elements to the discussion table than it’s being imagined. Apart from nudging -- some will say pushing is required -- the financial system towards promoting green finance, central bankers can share their experiences of inflation targeting and whether and how they overcame the monster of inflation.

To control inflation, central bankers required patience, flexibility -- hence, they modified the approach to flexible inflation targeting -- and communicating with various stakeholders regularly and consistently. All these three elements -- and much more -- will be needed to conquer the mounting goal of climate change. Central bankers like Carney will be a good addition to the team of policymakers to address this urgent matter.

Amol Agrawal is faculty at Ahmedabad University. Views are personal.