For some time, the fight against climate change has become a priority for the European Central Bank (ECB). Many official speeches testify to this intention. This development seems somewhat alarming to us: however pressing is the issue of climate change, we believe that the ECB’s stance is formulated without the necessary intellectual rigour and therefore endangers the mission of the institution.
Since the 1980s, price stability has been hard-won. One of the reasons for this success is that central bankers have come to be the voice of reason. They base their doctrine on economic theory and on empirically established facts. They gradually learned to avoid logical fallacies, unsubstantiated assertions and the temptation to play politics.
The change in doctrine proposed to bring the ECB into the fight on climate change is based on an accumulation of rather vague and unconvincing arguments. The first fallacy is to use the severity of climate change to justify the ECB having to buy green bonds en masse through a €2.8tn green asset purchase programme. Poverty or education are also urgent and worthy causes: by this reasoning, the central bank would be entitled to invest in the construction of schools in poor countries.
Flawed reasoning
Another argument is that the central bank should intervene whenever financial stability is in danger. Fighting climate change would therefore come under policies aimed at limiting systemic risks to which the financial system is exposed. But sources of tail risk to the economy are numerous. Economic stagnation, social tensions, pandemics: the list goes on. Yet no central bank has yet had the idea of intervening to reduce the cost of capital in the biotech sector or to subsidise research about infectious diseases. Central banks cannot legitimately manipulate the relative cost of capital across sectors. But they can and should address systemic risk through banking regulation, by ensuring financial institutions can resist stress scenarios, which should of course include bad environmental outcomes.
Central banks cannot legitimately manipulate the relative cost of capital across sectors
Another argument the ECB is using to justify a green slant in asset purchases is that financial markets are short-termist and are clearly overestimating the value of polluting assets. Hence, buying green assets would be a win-win: increasing profits for the central bank while making the world better. This is a controversial view, however. The spectacular rise of environmental, social and governance (ESG) asset management and the prevalence of environmental topics in financial media makes it unlikely that investors are blind to climate change and to the tightening of environmental regulations. More formally, several papers document the fact that investors are indeed demanding compensation for their exposure to carbon emission risk (including, recently, a paper by Columbia Business School’s Patrick Bolton and Imperial College London’s Marcin Kacperczyk, Do investors care about carbon risk?), which results in a higher cost of capital for polluting companies.
Risk of a backfire
In addition, while the ECB could realistically achieve a slight additional increase in the cost of capital of polluting companies, this would by itself only have a marginal impact on pollution. Other sources of capital, notably outside Europe, could substitute ECB funds. Instead of being funded by the ECB, polluting assets will simply be owned and exploited by investors who care little about climate change. In other words, unless almost every investor on the planet goes green, avoidance of polluting assets by the ECB will have only a marginal effect on resisting climate change and could even backfire if doing so puts brown assets in the hands of less responsible owners.
In the case of a central bank, doctrines with weak foundations can severely damage credibility. Governments have delegated enormous powers to these institutions, and for good reason. The corollary to this independence is a relatively narrow mandate that does not accommodate actions reflecting, for example, the individual civic views of their leaders, even when they are clearly well-intentioned. If this were no longer the case, central banks would be called upon to solve problems beyond their original mandate and, if so, how can they resist political pressure? How will they be able to refuse financing the relocation of strategic industries, the reduction of inequalities or offering developmental aid to their geopolitical allies?
Topics such as climate change should remain within the sphere of politics and under democratic control. On this matter, it is governments that have the legitimacy and the effective tools to act.
Augustin Landier is professor of finance at HEC Paris. David Thesmar is professor of finance at MIT Sloan School of Management.
