10 March 2021

Vox EU: The ECB’s green agenda

Debates have emerged recently on central banks’ role in mitigating climate change... The February 2021 CfM-CEPR survey asked members of its European panel of experts about measures the ECB could take to address the environmental impact of its bond-purchasing policies.

The majority of the panel supports active measures to use the ECB’s bond-purchasing programme to either exclude industries with negative environmental impact or bias its portfolio towards green investments. An additional 30% of the panel believes that the ECB should rebalance its portfolio to correct its current bias in favour of polluting industries. However, a majority also believes it would be inappropriate to change the ECB’s mandate to reflect green objectives.

Concerns about climate change have been central to the economic policy discussion in recent decades, with increasing urgency. More recently, debates have emerged on central banks’ role in mitigating climate change, or on increasing their awareness of their environmental impact (Brunnermeier and Landau 2020). The February 2021 CfM-CEPR survey asked members of its European panel of experts about measures the ECB could take to address the environmental impact of its bond-purchasing policies, in light of some suggestions that the bonds the central bank purchases overweigh industries that have negative environmental impact. The panel was also asked whether it would consider changing the ECB’s mandate to contain environmental targets.

Concerns about the ECB’s environmental impact

The ECB has been on the forefront of thinking among central banks and climate policy is a central “work stream” of the Bank’s monetary policy review this year.1 

The ECB’s existing policy states that environmental externalities are best tackled by taxation, but that there is still potential scope for monetary policy to factor environmental concerns into its policy considerations. The ECB has already been doing so, having purchased green bonds under its asset purchase programmes, amounting to 3.5% of its portfolio (before the Covid-19 pandemic). The ECB’s annual report from 2019 states that “all authorities need to reflect on the appropriate response to climate change and related risks in their own area of competence” (ECB 2020).

The main argument for central bank action in this regard has been that the central bank’s actions are not ‘market neutral’. That is, the types of bonds typically purchased through central banks’ quantitative easing policies tend to be from larger firms that do more environmental harm on average than does the average firm. In this regard, the quantitative easing may be an implicit subsidy for fossil fuel and other ‘brown’ industries. 

In a recent lecture at the 2021 American Economic Association meetings, Monika Piazzesi presented work in progress (Piazzesi et al. 2021) that shows that the ECB’s bond portfolio is significantly different from the universe of outstanding bonds in the market and overweighs industries that are heavier in emissions (manufacturing, utilities, and transport), as these industries issue more bonds than do other sectors. She argues that the ECB should restore market neutrality by consciously tilting its portfolio towards green industries. Paul De Grawe goes further2 and argues that the ECB could actively tilt its portfolio towards green bonds and do so without stoking inflation.

Ferrair and Nispi Landi (2020) model a temporary green quantitative easing (QE) in a DSGE model and concur that this policy could be effective in mitigating emissions, but this requires imperfect substitutability between bonds of ‘green’ and ‘brown’ firms (an assumption also made in Piazzesi et al.’s analysis). Further, they find that green QE can only have a small positive impact on the environment because it cannot affect the stock of atmospheric carbon, only the flow of emissions.

In recent speeches, ECB President Lagarde has supported this view,3 arguing that “we have to ask ourselves as to whether market neutrality should be the actual principle that drives our monetary policy portfolio management”. Isabel Schnabel, an ECB executive board member, goes beyond market neutrality and argues for excluding bonds from the Bank’s portfolio that are inconsistent with the EU’s target to be carbon-neutral by 2050. President of the Bank de France, François Villeroy de Galhau, also supports this idea,4 calling for “decarbonising the ECB’s balance sheet in a pragmatic, gradual and targeted manner for all corporate assets, whether they are held on the central bank’s balance sheet or taken as collateral”.

Other central bankers are less supportive of this shift. Jens Weidmann, president of the Bundesbank, wrote in the Financial Times that “it is not up to us to correct market distortions and political actions or omissions”,5 adding that “the market price of carbon” is an issue for governments to address — not central banks.” Otmar Issing, the Bank’s former chief economist has written that “[c]entral bankers who would assume responsibility for tackling climate change are acting out of pretention, and could well undermine the very independence upon which their institutions rely. Central banks were not made independent so that they could extend their own mandates. And where environmental issues are among their secondary objectives, central banks should warn against exaggerated expectations regarding their contribution. Making themselves publicly accountable beyond their limited capability in this field must lead to disappointment and undermine their reputation.”6 

There are also reasons to be sceptical whether a change in the ECB’s portfolio will have much more than a symbolic effect on a transition to climate neutrality. Hassler et al. (2020) predict that reducing the price (and thus the financing costs) of green technologies alone is not an effective substitute for emission pricing. This is because green and brown technologies are not sufficiently substitutable for lower priced green technologies to ‘outcompete’ brown ones.

Beyond market neutrality, climate change itself may have important implications for price stability. As Volker Wieland pointed out in his 2020 presentation to the ECB Forum on Central Banking,7 increased energy prices due to CO2 pricing may lead inflationary pressures and have a negative impact on growth, as in a traditional cost push (see also Garnadt et al. 2020.) These factors may affect the type of policies the ECB needs to pursue to fulfil its targets of medium-term price stability while attempting to ensure full employment. 

In this month’s survey, members of the CfM-CEPR European panel of experts were asked about their views on policies that have been proposed to address the environmental impact of the ECB’s bond-purchasing programme. ...

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