Central Banks and Climate Change (Part 2). Can Central Banks Intervene Now? And How? Arguments of “Opportunity” and “Suitability”

David Ramos Muñoz; Antonio Cabrales; Ángel Sanchez

ABSTRACT

Climate change is humanity’s defining challenge for the twenty-first century. Central banks have for a long time been absent from the regulatory picture, but today, this is no longer the case. Having showed in Part 1 that climate change considerations fit within central banks’ mandates, this Part 2 now analyzes why central banks can and should act now (opportunity), and then how they should act (suitability). Central banks should act now not only because the cost of waiting is too high, but also because complex models show that climate-related shocks would propagate through a networked financial system, rendering central banks powerless to act. In fact, careful consideration of the argument of opportunity makes it pertinent to ask why central banks did not act earlier. We offer two explanations; one based on the role of uncertainty and ambiguity aversion, and another on the role of slowly changing social norms. Then, we consider how the arguments for and against a proactive approach could play before the courts in the situation where central banks actions are challenged. Then, we show that the current debate on “suitability” is full of misunderstandings. Objections that central banks are “unsuitable” tend to ignore that central banks do not have “one tool”, but rather a vast arsenal of tools, and that the risks of endangering “market neutrality” or “independence” should be analyzed in case of both action and inaction. Upon closer consideration, central banks are not asked to exercise new competences or skills, or to upend their mindset, but rather to deploy some of their tools in a precise and time-consistent manner. There are obstacles, of course. Central banks are uncomfortable mixing “assertion” and “persuasion”; negative, “brown” approaches may be more effective, but more conflictual. Living with conflict, and trial-and-error may be a given to execute their mandate well in this new setting, but it is a challenge nonetheless.

To overcome it, we need a renewed commitment to central bank independence, but also a gradual change in central bank practices to foster dialogue with democratically elected bodies. This two-pronged approach will place central banks in an adequate role for the twenty-first century, and bolster their legitimacy, and courts should act as gatekeepers.

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