The pandemic could easily have derailed Christine Lagarde’s plan to enlist the European Central Bank in the fight against climate change. Only she won’t let it. “It’s a topic that I am very keen about, which I believe has a systemic dimension,” she told journalists after the ECB’s latest monetary policy meeting on Sept. 10.
According to Bloomberg, Lagarde made battling global warming a defining feature of her eight-years as managing director of the International Monetary Fund, warning that humanity would be “roasted, toasted, fried and grilled” if it failed to act.
She reiterated that message as she vied to become the ECB’s first female president last year, telling members of the European Parliament that combating climate change should be “mission critical” for the Frankfurt-based institution, which sets monetary policy for the 19-nation euro zone.
Lagarde had been at the helm less than four months when Italy recorded its first death from Covid-19 on Feb. 21. Suddenly, the deadly new virus assaulting the continent posed a more clear and present danger than greenhouse gases. The immediate imperative was propping up the euro-area economy, which shrank almost 15% in the second quarter, compared with the same period last year—the most on record.
Instead of allowing the Covid-19 recession to bump climate off her agenda, Lagarde has used it to try to persuade skeptics that phenomena such as global warming are well within the remit of monetary policy, a notion that some of her European peers, notably Bundesbank President Jens Weidmann, have resisted. Across the Atlantic, the chairman of the U.S. Federal Reserve has also been lukewarm on the idea. “Society’s overall response to climate change needs to be decided by elected officials and not by the Fed,” Fed chairman Jerome Powell said in January.
Lagarde’s argument is that the ECB will not be able to deliver on its mandate to preserve price stability or properly carry out its supervisory functions if it does not stay vigilant against threats from new and unexpected sources. This year, a virus brought the world economy to a nearly complete halt. Is it really unimaginable, asks the ECB’s new chief, that the next economic or financial crisis might be triggered by a devastating series of natural disasters, such as a string of wildfires or floods?
“It’s absolutely crucial to be prepared,” says Sabine Mauderer, a board member at the Bundesbank. “The question is no longer ‘if’ but ‘how’ we can play an active role in the fight against climate change.”
Prior to her confirmation, Lagarde floated several ideas for how the ECB could take steps to help alleviate global warming. The most radical involved greening the bank’s massive quantitative easing program (QE), in which it buys bonds from banks to lower interest rates. Lagarde suggested the bank should prioritize purchases of environmentally friendly securities, but noted this could not be done overnight. The European market for green corporate bonds is still small, at around €100 billion ($118.7 billion), and the institution must take care not to crowd out other investors.
Her comments met with resistance from inside and outside the institution. The most frequently invoked objection against what Lagarde was proposing is that the ECB must strive always to be market-neutral. If the bank were to favor debt issued by makers of wind turbines over that of oil majors, it would open itself up to accusations that it was charting its own industrial policy.
“Central bankers are not elected officials and they should not replace or bypass the necessary debates in civil society,” the Bank for International Settlements wrote earlier this year. “Mitigating climate change requires a combination of fiscal, industrial and land planning policies (to name just a few) on which central banks have no experience.”
Those arguments don’t register with everyone. Just this month, Reclaim Finance, a green NGO, reiterated its demand that the ECB immediately exclude companies developing new fossil fuel projects from its stimulus programs.
Other advocacy organizations have adjusted their expectations after several exchanges with Lagarde. “Green QE was a campaign slogan to get the conversation going, but the discussion has moved on,” says Stan Jourdan, executive director at Positive Money Europe, a research and lobbying group promoting a sustainable economy. “Climate change has become part of the strategy review, so we’re thrilled to see the consensus growing for policy action from the ECB.”
At the start of her term, Lagarde launched a comprehensive review of the monetary policy toolkit, the first since 2003. Results are expected by about the middle of next year. The exercise presents a unique opportunity to enshrine climate goals in the ECB’s framework.
A few potential areas for action on climate stand out. Much like any central bank, the ECB relies heavily on economic models when setting monetary policy. More frequent natural disasters and the many consequences they entail—higher insurance premiums and capacity lost due to destroyed factories, as well as money invested to rebuild—can have a direct impact on projections for growth and inflation. The current models could be revamped to better capture what’s at stake.
The bank could also insist that bond issuers become more transparent about their exposure to climate risk if they want their assets to be considered for purchases and lending. For instance, an electric utility might be required to reveal that proceeds from a bond issue were earmarked for the construction of a coal-fired plant—information that could affect the security’s credit rating and price. This is one of the most concrete proposals that has been floated, and judging by how carefully central bankers choose their words when speaking publicly, there might already be consensus that it should be implemented.
Another idea floated by François Villeroy de Galhau, who heads the Banque de France, is tweaking policies on the collateral that banks must post when they come to the ECB for funding, so that so-called brown bonds would get a bigger haircut than green ones. (In finance, the term haircut refers to the difference between an asset’s market value and the amount that can be used as collateral for a loan.)
There are areas in which the ECB can have a freer hand in making changes. Like many institutional investors, it has become more environmentally mindful in the pension-fund investments it makes on behalf of its more than 3,700 employees.
Lagarde isn’t he only central banker engaged with these issues. In 2015, then-Bank of England Governor Mark Carney told an audience of bankers in London that “the challenges currently posed by climate change pale in significance compared with what might come.” He argued that while setting climate policies falls to governments, central banks and other financial sector regulators are not entirely off the hook. “Financial policymakers do, however, have a clear interest in ensuring the financial system is resilient to any transition hastened by those decisions, and that it can finance the transition efficiently.” Two years later, a group of eight central banks and financial regulatory agencies started the Network for Greening the Financial System. Its membership has since grown to 69.
Some of Lagarde’s strongest support comes from Brussels, where European Commission President Ursula von der Leyen is shepherding the rollout of a Green Deal that envisages zeroing out Europe’s net carbon emissions by the middle of this century. Seeing governments push ahead with climate-friendly initiatives helps the ECB justify its own actions—supporting the region’s general economic policies is part of the central bank’s job.
James Nixon, whose work at Oxford Economics includes modeling the costs of climate change, believes that aligning monetary as well as fiscal policy on climate has the potential to slow global warming. “Fighting climate change will bring about the biggest industrial revolution the economy has ever seen,” he says. “It’s an enormous challenge, and central banks have a huge role to play.”