Navigating the Transition to Net Zero

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Central banks have a choice when it comes to dealing with climate change, BlackRock’s Isabelle Mateos y Lago said at a recent Hutchins Center on Fiscal & Monetary Policy event. They can navigate climate change and the transition to net zero carbon emissions, or they can go further and drive the transition to net zero emissions. But ignoring climate change is not an option.

Mateos y Lago, global head of the Official Institutions Group at BlackRock and a former top official at the International Monetary Fund, spoke at a Hutchins Center forum in early March 2022 about the challenges Jerome Powell faces during his second four-year term as Fed Chairman. Climate change is a particularly controversial issue. Senate Republicans are blocking Sarah Bloom Raskin’s nomination to the Fed as Vice President of Supervision (Banking), in part because she has said in the past that the Fed should take an aggressive role in combating climate change. This is a slightly edited summary of his remarks. (Video is also available.)

Climate change clearly poses a significant economic threat, Mateos y Lago said. “There are all sorts of estimates on the impact of climate change, but the one we like to quote is that the damage from climate change under a business as usual scenario would be equivalent to 25% of global GDP by 2040,” said she declared. “So we’re not talking about the second half of this century when we’re all dead. We are talking about the next 20 years. For the United States, this figure is 8%. It’s very material.

So what does this mean for the Federal Reserve? Powell said the Fed’s role is limited, but important. “And I think that’s a brilliant line,” Mateos y Lago said. “Most central bankers would agree with that. No central bank in the world is asking to expand its mandate to include saving the planet. No central bank is calling to fill a void left by other policymakers. That said, they have different understandings of what falls under this limited but important role.

Central banks, she said, strive for maximum overlap between their legal mandate (in the United States, maximum employment and price stability) and what she called “their social license to operate”, both of which differ by country and change over time. For decades, neither mandate nor social license led central banks to take climate change into account.

But that has changed, and that’s not the only thing that has changed. The Fed in 2020, for example, redefined “maximum employment” as a “broad and inclusive goal”. Why? “Because he felt it made sense within his tenure and because he felt his social license to operate required it,” Mateos y Lago said.

Given the political division of climate change discussions in the United States, Mateos y Lago suggested that the Fed wants to err on the side of sticking to what the legal mandate requires, which is to navigate in climate change rather than driving the policy response. Powell’s public statements reflect this approach, aimed at ensuring Fed-supervised banks understand and manage the risks posed by climate change, including stress testing with various scenarios.

“And that’s really important because this stuff is complicated, most institutions don’t have the data to understand how the scenarios can be constructed for them to make sense, it all takes time. And so there’s a lot of learning-by-doing that needs to happen, so it makes sense for the Fed to do that,” Mateos y Lago said. “That doesn’t include green lending incentives or penalties for lending brown. Some central banks feel that their population, their public opinion, wants them to do it, and they have done it. This is not the case in the USA

Given the potential macroeconomic impact of climate change – or policies aimed at reducing the damage of climate change – “it would be completely odd if central banks did not incorporate this as best they could into their macro modelling”, she said. “We face a massive reallocation of resources across the economy over the next 10 years. But do you want to do that with a 2% inflation target or a 4% inflation target? You know, having a slightly higher one could probably help.

The scope of the Fed’s climate approach will evolve over time. The key, she said, is “not to go overboard and become hostage to political debates…. But there are also core elements that fit squarely within the Fed’s core financial stability and monetary stability mandate. Not talking about climate change just because it’s polarizing wouldn’t be a good idea either.


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