Central Banks Cannot Save The World From All The Swans

COMMENTARY Monetary Policy

Central Banks Cannot Save The World From All The Swans

Feb 27th, 2020 5 min read
COMMENTARY BY
Norbert J. Michel, Ph.D.

Director, Center for Data Analysis

Norbert Michel studies and writes about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.
It makes sense for central banks to focus on what they can accomplish. Leading a “structural transformation of our global socioeconomic system,” is a bit outside their expertise. Hirkophoto/Getty Images

Key Takeaways

The Bank of International Settlements (BIS) is a collection of most of the world’s central banks.

Their mission is to “serve central banks in their pursuit of monetary and financial stability,” and to “foster international cooperation in those areas.”

Their latest foray into telling everyone what to do is a book called "The Green Swan: Central Banking And Financial Stability In The Age Of Climate Change."

The Bank of International Settlements (BIS) is a collection of most of the world’s central banks. Their mission is to “serve central banks in their pursuit of monetary and financial stability,” and to “foster international cooperation in those areas.”

Their headquarters are in Basel, Switzerland, and they are responsible for the risk-weighted capital requirements known, for obvious reasons, as the Basel rules. Those rules, forced upon all U.S. banks in the 1990s, required banks to have less capital for holding the sovereign debt and mortgage-backed securities that contributed to the 2008 financial crisis.

Their latest foray into telling everyone what to do is a book called The Green Swan: Central Banking And Financial Stability In The Age Of Climate Change. The title is a play on the term black swan, and it refers to unpredictable/uncertain events due to climate change that have potentially devastating consequences. That the BIS would produce a book on this topic is no surprise. After all, it helped launch the Central Banks and Supervisors Network for Greening the Financial System back in 2017, at the Paris One Planet Summit.

Also unsurprising: the book supports the “textbook solution to mitigating climate change”—i.e., “a globally coordinated Pigovian carbon tax.” The problem, though, is that the authors view the prospects for such a tax as next to nonexistent in “the current political and economic environment.”

Nonetheless, the book calls for “a structural transformation of our global socioeconomic system” as the only way to “really shield the financial system against ‘green swan’ events.” It is difficult to see how a complete transformation of the “global socioeconomic system” is easier to accomplish than implementing a carbon tax, but maybe the central bankers have a few tricks up their sleeves.

More troubling, though, is the following passage from chapter 4:

While banks in financial distress in an ordinary crisis can be resolved, this will be far more difficult in the case of economies that are no longer viable because of climate change. A potential intervention as climate rescuer of last resort would then expose in a painful manner the limited substitutability between financial and natural capital, and therefore affect the credibility of central banks. 

Regardless of what one thinks about climate change, the credibility of central banks when economies are no longer viable—whether due to an ice age or an inferno—might not matter too much. The passage is also a bit amusing because it essentially reveals that the BIS wants to make sure climate disasters don’t expose the truth: central banks cannot save everyone from every possible disaster.

The book sounds somewhat practical when it says that “[o]n the other hand, central banks cannot succumb to the growing social demand arguing that, given the severity of climate-related risks and the role played by central banks following the 2007–08 Great Financial Crisis, central banks could now substitute for many (if not all) government interventions.”

It is also reassuring that the authors acknowledge that “accounting for the multiple transmission channels of climate-related risks across firms, sectors and financial contracts while reflecting a structural change of economic structures remains a task filled with uncertainty.”

But the book does say that such uncertainty should not be an excuse for inaction, and it argues for all sorts of central bank policies that suggest more than merely succumbing to any “growing social demand.”

For instance, the book argues for the following actions.

  • central banks must be more proactive in calling for broader and coordinated change.
  • banks with more exposure to “brown” assets versus “green” assets should be subject to higher capital requirements (i.e., a “brown penalizing factor should be included in capital requirements”).
  • prescribing additional capital on a case-by-case basis—for instance, if a financial institution does not adequately monitor and manage climate-related risks.
  • having central banks and supervisors help disseminate the adoption of so-called environmental, social and governance (ESG) standards in the financial sector, especially among pension funds and other asset managers.

The book also points out that “governments could play a much more critical role in supporting sustainable investments,” and that they might want to offer “a public guarantee on all household savings channeled to long-term SRI [socially responsible investments] vehicles (and certified as such).”

There is no doubt that taking this approach will hyper-politicize central banks, so it is a good thing that the Federal Reserve is not interested. According to Chairman Jerome Powell, addressing climate change should not be the responsibility of central banks, even if they do face the job of keeping the financial system "resilient and robust" against such risks.

Hopefully, Powell keeps the Fed out of this international morass and focused on its congressional mandates. That course of action is perfectly reasonable regardless of what happens with climate change. No matter what, central banks will still be able to do what they are designed to do: buy assets and provide liquidity.

It makes sense for central banks to focus on what they can accomplish. Leading a “structural transformation of our global socioeconomic system,” on the other hand, is a bit outside of their expertise. It might even be a bad idea to try.

This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2020/02/26/central-banks-cannot-save-the-world-from-all-the-swans/#be81f63767f8