Remember early 2020? U.S. unemployment below 4%. The global economy expanding. And major financial institutions had turned their attention to the simmering crisis of the day: climate change. BlackRock CEO Larry Fink said that a new understanding was emerging that “climate risk is financial risk.”
Global, coordinated action to move toward a low-carbon economy this decade seemed likely.
Then coronavirus brought the economy to its knees. Unemployment soared to 13% in the second quarter and still hovers just above its Great Recession peak. The economic pain will probably last years.
Central banks were quick to act. The Federal Reserve expanded its portfolio of securities from $3.8 trillion in early March to $6.3 trillion by mid-August, with the European Central Bank (ECB) and others following suit. At the end of August, Fed Chairman Jerome Powell indicated interest rates will stay very low, for a long time—a clear acknowledgment that this crisis—and the risks it poses to economic growth and price stability will consume policymakers for the foreseeable future.
Where does that leave the finance and banking sector when it comes to the climate emergency?
Green Swans on the Climate Horizon
Central bankers, whose words can move markets, are not easily riled up. Which is why it was noteworthy when the Bank for International Settlements—think of it as the central bank of central banks—published a paper outlining “green swan risks”: climate-linked financial crises.
The report warned that central banks may be forced to intervene as “climate rescuers of last resort,” buying up a large quantity of devalued carbon-intensive assets—think fossil fuels and aging energy infrastructure, or “brown technology” assets—to head off a financial crisis triggered by capital flight from carbon-intensive industries.
That report last January wasn’t even the initial alarm bell. At the San Francisco Fed’s first climate change conference in November, 2019, Professor Nicholas Muller of Carnegie Mellon University warned that climate change could permanently restrict economic growth and give rise to a depressed “green” interest rate. And Professor Michael Barnett of Arizona State University said that as economies switch from carbon-based “brown energy” to greener alternatives, the value of brown technology assets could decline so much that they become liabilities.
None of these concerns were new. Bank of England Governor Mark Carney’s famous 2015 speech declared that “the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors.” He warned, “once climate change becomes a defining issue for financial stability, it may already be too late.”
Central banks are hearing these warnings. Nearly 70 have joined the Network for Greening the Financial System, formed in 2017. And in late 2019, ECB President Christine Lagarde said climate change risks should be incorporated into economic forecasts and, potentially, banking stress tests.
The Federal Reserve is staying out of climate change, for now. Fed Chairman Jerome Powell has said climate change is a “first-order issue,” but not one for central banks to solve. Pressure is mounting for that position to change; a Senate report released in August pressed the Fed to take further action to incorporate climate change risks into its oversight activities. And better late than never. I think the Fed has little choice but to reckon with the game-changing financial risks posed by climate change.
The Coronavirus Curveball
The economic toll of climate change is already beginning. In 2019, the U.S. suffered 14 extreme weather and climate disasters with price tags of more than $1 billion each. Wildfires in California and Hurricane Laura’s rapid intensification are recent reminders that the risks of climate change have not evaporated in the pandemic.
Wildfires in California and Hurricane Laura’s rapid intensification are recent reminders that the risks of climate change have not evaporated in the pandemic.
Climate concerns are likely to take a back seat to coronavirus until the long-term impact of the present crisis becomes clear. Already, the economic fallout from containment measures has been severe. The Congressional Budget Office’s July economic outlook reported that the pandemic “ended the longest economic expansion and triggered the deepest downturn in output and employment since World War II.” Inflation, the CBO projects, will not recover until 2022, and economic growth may not return to pre-pandemic levels until 2028.
Central banks would be foolish not to make the coronavirus crisis their top priority. Most are turning to quantitative easing to ensure liquidity and prop up asset prices. The Fed, for example, has unlimited authority to buy Treasuries.
Some pundits, particularly in Europe, suggest using coronavirus stimulus measures to accelerate the shift away from carbon. They’re calling on central banks to buy green bonds in addition to government debt. Such green quantitative easing would direct capital toward sustainable industries and incentivize firms to tap cheap financing for green initiatives. Proponents of the idea may have reason for optimism; in July, Lagarde suggested the ECB could pursue environmental objectives with its €2.8 trillion asset purchase scheme.
Critics say the rules defining “green” investments are too new to be implemented widely, let alone during an emergency. Others note that central banks’ resources are just too big: they could swallow the market for green bonds and distort green debt markets in unknowable ways.
Whether climate is or isn’t factored into coronavirus stimulus or concurrent central bank activities, a green financial system alone won’t solve the emergency.
Even though the pandemic response may divert central bankers’ attention for a while, they should continue plotting a course toward sustainability.
A Policy Conundrum Bigger than Banking
The En-ROADS policy simulator from Climate Interactive and MIT Sloan School of Management shows just how maddening the situation is. Without major changes to energy and land-use policies, and keeping global GDP per capita growing at a moderate 2.5% annually, En-ROADS predicts average global temperature will increase four degrees Celsius by 2100. That’s double the limit of the Paris Agreement.
A modest tax on fossil fuels, large subsidies for renewables, and incentives for efficient land use would at least keep the world below a three-degree rise, but even that’s too high. Only whole-of-society approaches that include carbon pricing , innovation and lifestyle changes are likely to get us where we need to be.
Before the pandemic, the conversation from Davos to San Francisco to Sydney made clear that we are entering a decade of action. Central bankers have a central role to play and cannot take a “wait and see” approach. Coronavirus shouldn’t change that. It’s one of any number of crises we may see on the road to a low-carbon economy. Even though the pandemic response may divert central bankers’ attention for a while, they should continue plotting a course toward sustainability.