MEIG Highlights 16 avril 2021

Highlight 14/2021 – Monetary policy and climate change

Yerlan Danenov, 16 April 2021

Climate change has become a significant structural element shaping the state of the global economy, affecting all economic stakeholders and sectors across the globe. While the interplay between climate change and industrial / financial sectors is on the surface, one could ask if there is a link between climate change and monetary policy.

The monetary policy is implemented by a central bank, with the primary purpose of maintaining price stability, mainly implying decision-making over inflation and exchange rates policies. Other macroeconomic outcomes, including financial sector supervision, are generally secondary objectives.

Central banks are gradually acknowledging that climate change is becoming part of their monetary policy environment. It comes mostly through the “supply-side shocks” – events that pull inflation and output in opposite directions, impacting the cost of goods and services, on a temporary or permanent basis. For instance, a drought and a flood can result in crop shortfalls and infrastructure damage, leading to increased food prices and production costs. The sea level rise may destroy the productive lands. For the central banks, the natural disasters pose a dilemma, whether to stabilise inflation or let it increase that would allow stronger short-term growth but may hinder long-term perspectives. Also, climate change may complicate the correct identification of shocks used in inflation outlooks.

Besides taking into account climate change related risks, many central banks are also being called to contribute to fighting climate change. Indeed, monetary policy may contribute to climate change mitigation efforts through various channels:  purchasing low-carbon bonds; “greening” credit allocation policies; providing better access to funding for commercial banks that invest in low-carbon projects; ensuring climate risks are appropriately reflected in central bank asset portfolios.

Some of these mechanisms require friendly political and economic background as financial rationale may not be sufficient. For instance, purchasing “green bonds” may be interesting as long as the markets are liquid enough. Very often, central banks’ portfolios are composed of the most creditworthy assets in a few major currencies, leaving little room for climate-related objectives. In the case of the European Central Bank, the institution is expected to support the general economic policies of the European Union. Considering that fighting climate change is now a major pillar of the EU agenda, the ECB may use some of its instruments to pursue a climate change objective, on a condition that price stability objective is not compromised.

Meanwhile, the appearance of such global frameworks as the United Nations Principles for Responsible Investment, requiring the incorporation of environmental, social and corporate governance (ESG) standards into the voting policies, provides an additional incentive to invest in sustainable financial products and consider “greener” monetary policy. All in all, even though the correlation is not overt, the climate change has the capacity to influence the conduct of monetary policy while the latter have the tools to impact climate change.

Yerlan DANENOV, Monetary policy and climate change, Highlight 14/2021, available at

The views expressed in the MEIG Highlights are personal to the author and neither reflect the positions of the MEIG Programme nor those of the University of Geneva.


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