The Covid-19 pandemic has revealed the fragility of the economy, and its susceptibility to large-scale, poorly-anticipated shocks. Yet, the potential for deep and irreversible losses stemming from climate change and environmental destruction is greater than the those associated with the Covid-19 pandemic, perhaps by orders of magnitude. However, the effects, valuation and temporality of for example climate change or biodiversity loss make meaningful evaluations of scales of damages speculative at best. This uncertainty has led policymakers into a trap: because the anticipated costs of unsustainability are so uncertain, policy responses frequently regard the problem as one for other agencies to tackle, or lead to policy paralysis. This is particularly true of central banks, which regard their independence from so-called ‘political’ considerations as an unbreakable axiom which helps to ensure democratic accountability.
The pandemic emergency purchase programme
In this vein, the EU’s recently expanded monetary policy operations for the purposes of financial and price stability have come into sharp focus. The extraordinary monetary policy interventions of the European Central Bank (ECB) began following then-ECB President’s Mario Draghi’s commitment in 2012 to do ‘whatever it takes’ to preserve the integrity of the Eurozone. As Europe has reached another watershed moment in its development, the ‘whatever it takes’ mantra has been resurrected, as the ECB has pledged to engage in large-scale bond-buying under a new ‘pandemic emergency purchase programme’ (PEPP). The PEPP, which operates in a similar fashion to past extraordinary monetary policy programmes, will eventually reach at least €1.35tn in total, a figure equivalent to over one-tenth of eurozone GDP.
However, as is the case with previous ECB monetary policy operations, the PEPP is likely to run counter to many of the EU’s other stated priorities, in particular its goals relating to climate change and sustainable finance. Analysis by Greenpeace reveals that a large proportion of the €30 billion of corporate bonds purchased between March and mid-May 2020 under the PEPP was allocated to companies engaged in, or heavily linked to, fossil fuel activities. Specifically, Greenpeace found:
- €2.4 billion went into bonds of integrated, upstream and downstream oil and gas companies, including Shell, Total, Eni, Repsol and OMV, whose combined bond purchase carbon footprint is almost 8 million tons of CO2;
- €4.4 billion went to utilities, with the bond purchases of prominent fossil-fuel corporations Engie and EON alone contributing an estimated 3.2 million tons of CO2; and
- €5.6 billion went into industries such as aerospace, automobiles, cement, and other environmentally damaging companies, including Airbus, Daimler and Peugeot.
Rhetoric vs Reality
How does this sit with the express mission of the European Union in the context of sustainability? For context, let us briefly examine some recent statements from senior EU officials on the topics of sustainability and climate change:
‘I think you have to be ambitious…and the fight against climate change cannot wait. I mean it's not waiting for politics to move. Either we change in a positive way or it's going be very bad for our planet and then bad for us.’
- Ursula Von Der Leyen, President of the Commission
‘Climate change is actually a threat to financial stability … [the ECB has to] at least try to explore every area where we can actually participate … I think that failing to try is already failing.’
- Christine Lagarde, ECB President
‘Our planet is in a state of emergency. We cannot sit and watch while hundreds of species are becoming extinct every day, glaciers melt and natural disasters claim thousands of human lives. Political leaders bear a historic responsibility… Europe stands ready to lead by example when it comes to serious climate action and to support other regions in the world to move forward as well.’
- David Sassoli, EU Parliament President
It is hard to make the case that these claims are matched by the actions of the ECB. Indeed, the contrast between the ECB’s actions in relation to sustainability, as represented by its asset purchases and the rhetoric on sustainability from Brussels, Frankfurt and elsewhere in the EU, demonstrate that a troubling yet persistent gap remains between public commitments to sustainable finance and the actions of the EU’s monetary authorities.
The ECB’s monetary policy and sustainability
The ECB’s primary mandate is price stability, something which they remind us of on a frequent basis. In pursuing this through bond-buying, the ECB is to have regard to a policy of ‘market neutrality’; that is, it conducts purchases in a gradual and broad-based manner, aiming not to favour purchases of bonds of particular sectors. Ostensibly, it does this to avoid interfering with the market price formation mechanism. But can the ECB, in light of the EU’s goals and commitments as concerns climate change and sustainability more broadly, remain neutral with respect to the carbon intensity of its collateral assets?
At a basic level, the Eurozone’s bond markets are imperfect representations of the EU economy as a whole, with carbon-intensive companies such as fossil-fuel companies, utilities, airlines and car manufacturers, which are relatively capital-intensive and therefore heavy users of borrowing, over-weighted in European bond markets. The main consequence of this is that EU monetary policy operations exhibit a ‘high-carbon skew’, with potential long-term impacts on environmental sustainability. According to the LSE Grantham Centre, the bulk of corporate bond purchases in past EU quantitative easing programmes were made in the two most carbon-intensive sectors of the economy: utilities and manufacturing. Oil and gas company bonds comprised 8.4 percent of ECB quantitative easing, yet no assets relating to renewable energy companies were purchased. Where a central bank purchases corporate bonds, those bonds become more liquid, raising their prices and depressing their yields (making it cheaper for the borrowing corporation to raise finance). This helps to lock-in prevailing carbon-intensive business models across the EU and entrench the comparative funding advantage enjoyed by large corporations. In other words, ECB policies directly promote the interests of fossil-fuel corporations and damage smaller, more environmentally-friendly companies.
At a deeper level, the approach taken by the ECB and other central banks in their monetary policies raises far-reaching questions concerning central bank independence and the relationship between central bank objectives and those of other high-level EU governmental agencies. For many, the financial crisis and now the current Covid-19 crisis have challenged the model of central bankers as passive agents concerned only with price and financial stability.
Options for reform
Central bankers cannot continue to claim that they are entirely apolitical, when their strategies and policies impart such far-reaching distributional consequences. Interest rate changes themselves affect welfare in highly varying ways. In fulfilling their financial stability function, central banks often make choices of a political nature (for example, denial of credit to a certain class of borrowers). Overt recognition of the distributional consequences of central bank actions has begun to occur. Central banks, including the ECB, have already started to explore how their actions (or inactions) might interact with climate change and its role in financial stability, specifically, by including climate and environmental risks in their financial system monitoring tools. However, such recognition is by no means quick enough.
As we concluded in our report Financing the Transition to Sustainability, as a part of our recent SMART Project, other, more optimal solutions to such issues are available.
Because sustainability considerations are material factors in determining both economic prosperity and improving the social market economy and the quality of the environment, there must be a more nuanced treatment of the role(s) and independence of central banks. The ECB is permitted to use its mandate to support the financing of sustainable investments, where this does not conflict with its primary objective of maintaining price stability. We argue specifically, at a minimum, that:
- The ECB should amend its collateral framework to prioritise the acceptance of sustainable bonds, and disincentivise the use of non-sustainable assets as collateral.
- The ECB should also levy higher fees on financial assets that fund highly unsustainable activities when they are pledged in return for cash.
- The ECB also uses other tools to intervene to prevent credit build up in unsustainable ways.
These suggestions are merely the starting points for delivering a sustainable and socially-just European economy. They would go some way toward reducing the continued reliance on private financial markets to deliver sustainable outcomes, in spite of the substantial evidence that they cannot do so alone. Although there are other more radical steps to be taken in rectifying the unsustainable path we are on, introducing sustainability into ECB monetary policy would send a powerful signal to citizens and markets that the ECB remains ready to do ’whatever it takes’ to prevent environmental apocalypse.