Thirty or so years ago I was having a conversation with a fellow manager in the Reserve Bank’s Economics Department. I’d learned that he was working on a submission on superannuation policy issues. I was interested in the topic and so was he, but it wasn’t at all clear to me why we should be devoting scarce Bank resources to a topic that seemed well outside our mandate. Ah, he responded, “but savings behaviour might affect the natural rate of interest and anything that affects the natural rate of interest must be something that matters to the Reserve Bank”.
I used the story, off and on, for decades in making the point that while, in principle, almost anything that affected the economy might be something the Bank should be aware of, it didn’t justify us weighing in on, or spending scarce research resources, on matters so far from our core responsibilities no matter how interesting we, as individuals, might find the topic or how important the policy issue itself might (be thought to) be. “Stick to your knitting remains” sage counsel, perhaps especially for central banks who (rightly or wrongly) exercise significant discretionary policy power and need to build and maintain broad public confidence in their competence and impartiality in discharging those specific responsibilities. Get very involved in other areas and people will reasonably begin to suspect you are using a public platform for private political ends.
The recent enthusiasm of senior central bankers all over the world for opining on climate change issues seems to fit that bill. Whether it is about pushing personal political agendas or some desperate quest for relevance (as if macro stabilisation and financial stability weren’t quite significant enough challenges, especially as the world converges on the effective lower bound constructed by central bankers and their legislators) or (more probably, more commonly) some mix of the two isn’t clear. What is clear is the generally tenuous nature of the case being made.
There was a conference on such issues held last week, hosted by the Federal Reserve Bank of San Francisco. Perhaps our Reserve Bank had someone attending. I don’t really want to encourage this stuff, but if you are interested there are links to the papers here. As just one example of the tenuous nature of the connections, I clicked on a paper – forthcoming in a journal – with the promising title of “Climate Change: Macroeconomic Impact and Implications for Monetary Policy” by some Bank of England staff. I haven’t read the whole paper but the Abstract told me as much as I needed to know
Climate change and policies to mitigate it could affect a central bank’s ability to meet its monetary stability objectives. Climate change can affect the macroeconomy both through gradual warming and the associated climate changes (e.g. total seasonal rainfall and sea level increased) and through increased frequency, severity and correlation of extreme weather events (physical risks). Inflationary pressures might arise from a decline in the national and international supply of commodities or from productivity shocks caused by weather-related events such as droughts, floods, storms and sea level rises. These events can potentially result in large financial losses, lower wealth and lower GDP. An abrupt tightening of carbon emission policies could also lead to a negative macroeconomic supply shock (transition risks). This chapter reviews the channels through which climate risks can affect central banks’ monetary policy objectives, and possible policy responses. Approaches to incorporate climate change in central bank modelling are also discussed.
Note all the uses of “could”, “might”, “may” and not a mention that inflation – the key target for monetary policy – is primarily a monetary phenomenon. It all seems to boil down to something along the lines of “productivity shocks can affect potential output, and potential output is one of the inputs central banks often using in trying to gauge appropriate monetary policy. Oh, and policy uncertainty – in whatever areas – can act to hold back demand”. All that is true but (a) not obviously more true in respect of climate change than of numerous other innovations, positive and negative, and (b) shocks – surprises – are typically what creates problems for central banks and financial regulators, and yet a key theme of much of the rhetoric around climate change is the long-term, inexorable for some considerable time, nature of what is at work. Markets tend to be better able to take such structural trends into account than for genuine “shocks” – be they wars, financial crises or whatever. It is also striking that nothing in this vein that I’ve yet read illustrates any of the argument by reference to the climate change we’ve already experienced over decades.
But the contribution to last week’s FRBSF conference that really interested me was the speech by Lael Brainard, a member of the Federal Reserve’s Board of Governors. She is a policymaker, not just a researcher. Being the United States – unlike secretive New Zealand where monetary policy decisionmakers are hidden away from scrutiny behind the Governor’s apron strings – we get thoughtful speeches like this, even with the standard disclaimer that the views expressed are hers, not those of the Board of Governors collectively. One doesn’t need to agree with her to appreciate the openness.
Brainard is a centre-left economist. She was a senior political appointee in the Obama Administration (and slightly less senior in the Clinton years) and, as I gather it, pretty well regarded in those roles. She has now been a Fed governor for five years or so. And her topic was very much to the point: “Why Climate Change Matters for Monetary Policy and Financial Stability”. So one might think she would make as good a case as anyone could for central bank involvement in climate change issues (smart, rigorous, policy-focused, not really the ivory-tower type).
But if it was as good a case as could be made, I didn’t find it convincing – or even challenging – at all. Perhaps it is what happens when you speak to the converted, but whatever the explanation, it only reinforced my sense that central bankers are typically getting well out of their lane when they start weighing in on climate change. With the superfluity of researchers and senior officials the Federal Reserve system has, perhaps casting the net widely has fewer direct opportunity costs than it does for other, much smaller, central banks, but the reputational issues are just as real. You might like the central bank weighing in on your pet topic, but you really won’t when they weigh in on some other issue or cause you don’t like. Cumulatively it corrodes confidence in the system and in the operational independence of the central bank.
Brainerd steps through the possible implications for the Federal Reserve under various headings. The first is monetary policy. Here is the gist of her case.
To the extent that climate change and the associated policy responses affect
productivity and long-run economic growth, there may be implications for the long-run neutral level of the real interest rate, which is a key consideration in monetary policy. As the frequency of heat waves increases, research indicates there could be important effects on output and labor productivity. A shifting energy landscape, rising insurance premiums, and increasing spending on climate change adaptations—such as air conditioning and elevating homes out of floodplains—will have implications for economic activity and inflation.
As policies are implemented to mitigate climate change, they will affect prices,
productivity, employment, and output in ways that could have implications for monetary policy. Just on its own, the large amount of uncertainty regarding climate-related events and policies could hold back investment and economic activity.
All of which really boils down to only two points:
- relative prices change, neutral interest rates change and potential output changes,
- policy uncertainty tends to be bad for economic activity.
And that, really, is it. As it was, is now, and (no doubt) ever more shall be. There is (rightly) no suggestion that climate change (or measures in responses) will impair the Fed’s ability to achieve its inflation target or even any suggestion that the target might need to change. There is no sense in which she suggests the Fed’s instruments will be impaired. All that is there is really economic forecasting – and disentangling actual data to make sense of what is happening and why. In that sense, climate change issues are no more (or less) relevant to the central bank than a myriad of other sources of policy or market change and uncertainty. None of which is to suggest that climate change issues aren’t important, just that they aren’t something of particular relevance to a monetary policy central bank.
But what about the Fed’s financial stability role?
She starts this way
Similar to other significant risks, such as cyberattacks, we want our financial system to be resilient to the effects of climate change.
Which, at one level, is reasonable enough. We want our financial systems to be resilient, to all sorts of things, but there is no real attempt to demonstrate/illustrate that there is a significant systemic risk from climate change issues, or the associated policy responses.
She goes on
Although there is substantial uncertainty surrounding how or when shifts in asset
valuations might occur, we can begin to identify the factors that could propagate losses from natural disasters, energy disruptions, and sudden shifts in the value of climate exposed properties. As was the case with mortgages before the financial crisis, correlated risks from these kinds of trends could have an effect that reaches beyond individual banks and borrowers to the broader financial system and economy. As with other financial stability vulnerabilities arising from macroeconomic risks, feedback loops could develop between the effects on the real economy and those on financial markets. For example, if prices of properties do not accurately reflect climate-related risks, a sudden correction could result in losses to financial institutions, which could in turn reduce lending in the economy. The associated declines in wealth could amplify the effects on economic activity, which could have further knock-on effects on financial markets. Beyond these physical risks, policymakers in some jurisdictions are assessing the resilience of the financial system to so-called transition risks: the risks associated with the transition to a policy framework that curtails emissions.
All while offering no evidence at all that market pricing will not adjust – never perfectly but more or less okay over time – to the changes associated with climate (as to all manner of other changes over the years). One can always advance hypotheticals but (for example) serious stress tests need to be grounded in the real-world range of possibilities. In this case, as she goes on to note, it is hardly as if the private sector has been slower to get to these issues than central banks.
The private sector is focused on climate risks. Private-sector businesses—
including insurance companies, ratings agencies, data companies, and actuaries—are actively working to understand climate-related risks and make this information accessible to investors, policymakers, and financial institutions. Although this work is at an early stage, thousands of companies around the world are now reporting climate-related financial exposures to the Carbon Disclosure Project (CDP) under the guidelines of the Financial Stability Board (FSB) Task Force on Climate-Related Financial Disclosures (TCFD).12 Based on these disclosures, the CDP estimates that the 500 largest companies by market capitalization are exposed to nearly $1 trillion in risk, half of which is expected to materialize in the next five years.
That sounds like quite a large number, at least until one realises that the market capitalisation of (say) the S&P500 index is about US$26 trillion.
She ends her treatment of this topic thus
An essential element of our bank supervision and regulation duties is assessing
banks’ risk-management systems. We expect banks to have systems in place that appropriately identify, measure, control, and monitor all of their material risks. These risks may include severe weather events that can disrupt standard clearing and settlement activity and increase the demand for cash. Banks also need to manage risks surrounding potential loan losses resulting from business interruptions and bankruptcies associated with natural disasters, including risks associated with loans to properties that are likely to become uninsurable or activities that are highly exposed to climate risks.
Well, no doubt. But where is the evidence of systematic problems – ie ones large enough to actually matter for the health of the financial system? We’ve seen no such evidence advanced in New Zealand – for all the talk of a modest number of potentially uninsurable properties – and Brainard advances none in the US. Sure, you want your central bank to be alert to potential risks and posing probing questions, but given (a) the extent of structural change that occurs in any economy over several decades, and (b) the lack of any (apparent) severe adverse economic/financial effects from decades of climate change to date, the case for treating this as a high priority area for central banks seems weak, at least if they are doing their jobs, rather than advancing the personal agendas of their management. Where perhaps there is a little more reason for concern might be around ill-considered or uncertain (in application) government policy responses – a significant part of the cause of the last US financial crisis – but even then the primary responsibility for advice, analysis, and policy choices around climate change rests squarely with other parts of government.
I deliberately picked a US speech to write about, precisely because it wasn’t about New Zealand but also because it is calmly and moderately expressed. But our own central bank has been out again more recently. Perhaps reflecting the character of our Governor, their statements tend to be less calm and nuanced, and rather more crusading in nature. All this from a central bank that (a) constantly tells us it is seriously resource-constrained and (b) which hasn’t been doing a great job in recent years in commanding confidence in handling things that are squarely its responsibility (whether monetary policy or financial stability).
I wrote last week about the seriously-flawed, highly ideological, report of the Sustainable Finance Forum. The Governor, by contrast, put out a statement “commending” the report and, regardless of his own limited statutory mandate, burbling on about
enhanc[ing] our role in the greening of the financial system, and the managing of environment and climate related risks.
and seemingly uninterested in the fact that any mandate he has around economic performance is around short-term and cyclical issues, not long-term structural ones.
He then had one of his deputies – one with no known expertise in economics, monetary policy, or financial stability – publish a Herald op-ed (text also here) channelling the Governor and simply ignoring the specifics of the Bank’s mandate. For example
Sometimes, we are asked why we are placing such an emphasis on climate change, and that’s easy for us to answer. In our assessment, climate change could lead to material economic and financial stability impacts. Managing major risks to the economy, such as climate change, sits squarely within our core responsibilities and like all of our functions, we do this with a long term view for generations to come.
On this view, every bit of economic and social policy, strategic defence policy for that matter, or the potential future eruption of Lake Taupo is a matter for the Reserve Bank (“sits squarely within our core responsibilities”). It is simply nonsense and rather “imperial” in its overreach. And if the Bank thinks it has the funds to do such things – with no statutory mandate at all – it is simply overfunded and should have its budget cut.
She goes on
Globally, there is growing recognition of the role central banks and regulators have in understanding, managing and quantifying climate-related risks. By being more visible in this space we hope to encourage the financial sector to focus on not only managing risks, but opportunities, such as responsible, sustainable investment with long-term benefits.
Is any evidence banks and insurers aren’t focused on the material risks that matter (two important qualifications, as no one has yet managed to identify major issues here). Beyond, risk management the Bank veers very close to rank fiscal policy. It is not the responsibility – and should not be – of an independent central bank and prudential regulator to be trying to steer the direction of credit. What matters is that there is a good prospect of the bulk of debts being repaid, whatever the purposes they were taken on for.
The op-ed burbles on through the Bank’s own carbon emissions to a new role of counsellor-in-chief
Climate change can feel overwhelming at times and leave people confused about what they should or shouldn’t do to help the situation, but that does not mean inaction, quite the opposite.
Perhaps (or perhaps not, since uncertainty is real) but what has any of this to do with the Reserve Bank.
All ending with this extraordinary paragraph
As financial system participants we all need to actively look for opportunities to ‘finance the green’ and help New Zealand firms as well as our own organisations transition to lower emissions practices, and ensure we are well placed for a net zero world. It’s heartening to see that there are many businesses who are already well advanced on this journey. We now have a ‘road map’ from the work of the Sustainable Finance forum to help us all navigate and focus our collective efforts and we look forward to playing our role.
The sort of thing one might expect from a politician or a lobby group, but not from a senior public servant, charged (quite narrowly) with managing short-term economic fluctuations consistent with price stability and the soundness of the financial system. If is Ms Robbers and her boss think that Sustainable Finance paper is any sort “road map” we (and the Bank) are a lot more lost than most would think.
In that same Herald climate change supplement (31 October) another senior central banker was quoted, this time Christian Hawkesby, the Assistant Governor responsible for monetary policy and markets. He also was championing the idea that it is the Reserve Bank’s business to try to steer business strategies in particular directions
‘Again, just using an analogy from the asset management industry, when I started in asset management eight years ago, ESG investing (environmental, social and governance investing) was seen as a real niche and — if anything — was seen as potentially a marketing tool to use for niche investors. That’s moved now from being absolutely and completely mainstream in the sense that fund managers know that why would you invest in a company that doesn’t have a long-term future over the next 20 to 30 years.
“So our challenge at the Reserve Bank is to encourage banks and insurers to have that same approach to their lending and their relationships and take a commercial view that it’s actually going to be in the long run a benefit that they take those environmental and climate change factors into account.”
Whatever you think of ESG, it simply isn’t an appropriate role for the Reserve Bank to e trying to shape what factors banks should take into account when lending. Apart from anything else – not having the mandate, for example – they simply don’t have the knowledge or incentive to get things right, and bear none of the costs or consequences if they get things wrong. And it is a diversion from the day job – the one Parliament actually charged them with – of managing monetary policy consistent with price stability and promoting the soundness (not the wokeness) of the financial system.
But the Hawkesby comment that took me more by surprise was his response to a question about bank capital
Asked if banks and borrowers would get capital relief for sustainable lending if the central bank is serious about climate change, Hawkesby responded: “That’s not in the plan at the moment. But that is very well something we could move to. At the moment, the onus is on really getting banks and insurers to focus on the issues and look at it from their own commercial incentives.
Glad to hear it isn’t “in the plan” at present, but it shouldn’t be now or ever. We’ve just endured a year of the Governor and his acolytes trying to convince us that the financial system is in peril if he doesn’t hugely increase capital requirements, and one of his senior offsiders now won’t rule out capital requirement discount to advance the Governor’s environmental whims.
“Stick to your knitting” remains sage advice for central bankers – and probably for all senior public officials with any sort of independent role. There is a nice column along those lines in this morning’s Australian newspaper, citing RBA Governor Phil Lowe’s line from a recent speech
“I want to emphasise that the discretion we have and our broad mandate to promote the economic welfare of the Australian people do not constitute a licence for the Reserve Bank board to pursue or advocate economic policies outside our area.”
As Judith Sloan points out, Lowe isn’t very good at following his own advice, but wouldn’t it be nice to hear such words of restraint, actually practised, by our own Governor and his senior staff?
After all, those day jobs – the ones we actually pay them to do – haven’t done so well that they really command the sort of respect that might invite occasional restrained and judicious comments on other matters.
Instead, we are left only to presume they are using a public pulpit for private ideological ends, and for advancing causes favoured by their allies in the Beehive. There should never be able to be such a suspicion of a central bank that actually values its independence.