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Wednesday, September
04, 2019 /02:44PM / By William Oman, Imfblog / Header Image
Credit: Rattankun Thongbun/Getty Images By IStock
July 2019 was the hottest month ever recorded on earth,
with countries across the world experiencing record-breaking
temperatures. A prolonged drought is affecting millions of people in East
Africa, and in August 2019 Greenland lost 12.5 billion tons of ice
in one day.
A review of the literature by IMF staff
aims to spur discussion of what policies to mitigate climate change could or
should include. The review suggests that, while fiscal tools are first in line, they need to be complemented by
financial policy tools such as financial regulation, financial governance, and
policies to enhance financial infrastructure and markets, and by monetary
policy.
The stakes are
high. There is a broad scientific consensus that achieving
sufficient mitigation requires an unprecedented transition to a low-carbon
economy. Limiting global warming to well below 2 degrees Celsius requires reductions of
45 percent in CO2emissions by 2030, and reaching net zero by 2050. Despite the 2015 Paris
Agreement, greenhouse gas emissions are high and rising, fossil fuels continue
to dominate the global energy mix, and the price of carbon, remains defiantly low,
reinforcing the need for complementary policies.
The case for policy action beyond carbon
pricing
Our review of
academic and policy studies suggests that, currently, there are insufficient
incentives to encourage investment in green private productive capacity,
infrastructure, and R&D. At the same time, investments continue to pour into
carbon-intensive activities. These undesirable economic outcomes prevent the
needed decarbonization of the global economy. Decarbonization requires a
transformation in the underlying structure of financial assets-a transformation
that, studies suggest, is hindered by several deficiencies in the way markets
function.
First,
financial risks may not reflect climate risks or the long-term benefits of
mitigation, given many investors' shorter-term perspectives. Moreover,
financial risks are often assessed in ways that do not capture climate risks,
which are complex, opaque, and have no historical precedents.
Second, there
is a wide gap between the private profitability and the social value of
low-carbon investments. High uncertainty around their ability to reduce
emissions, as well as the future value of avoided emissions, makes low-carbon
investments unattractive to investors, at least in the short run.
Third,
corporate governance that favors short-term financial performance may amplify
financial "short-termism," while constraints in capital markets can lead to
credit rationing for low-carbon projects.
The above
review of previous literature suggests that, because they directly influence
the behavior of financial institutions and the financial system, financial and
monetary policies can play a key role in addressing these issues.
Possible policy tools suggested by
studies
The table
below summarizes financial and monetary policy options for climate change
mitigation, based on the above review of previous studies.
Policies that
have been proposed in the literature can be divided into two categories: climate
risk-focused and climate finance-promoting.
Climate risk-focused tools aim to correct the lack of accounting for climate
risks for individual financial institutions and support mitigation by changing
the demand for green and carbon-intensive investments, as well as their
relative prices.
On the
monetary policy side, examples include developing central banks' own climate
risk assessments, and ensuring that climate risks are appropriately reflected
in central banks’ collateral frameworks and asset portfolios. On the financial
policy side, tools include reserve, liquidity and capital requirements,
loan-to-value ratios, caps on credit growth, climate-related stress tests,
disclosure requirements and financial data dissemination to enhance climate
risk assessments, corporate governance reforms, and better categorization of
green assets by developing a standardized taxonomy.
Climate finance-promoting policies seek to account for externalities and
co-benefits of mitigation at the level of society-that is, to account for how
economic activity harms the environment but could instead, in addition to
mitigating climate change, generate social value through, for example, reduced
air pollution or more rapid technological progress. These policies could help
shift relative prices and increase investments. However, the fact that they add
new goals to existing policies makes them more controversial.
Monetary
instruments to promote climate finance include better access to central bank
funding schemes for banks that invest in low-carbon projects, central bank
purchases of low-carbon bonds issued by development banks, credit allocation
operations, and adapting monetary policy frameworks.
Financial
policy instruments to actively promote climate finance revolve around "green
supporting" and "brown penalizing" factors in banks' capital requirements, and
international requirements of a minimum amount of green assets on banks' balance sheets.
What’s the bottom line?
More work is needed. The literature remains limited on the desirable package of measures to address climate mitigation. Nonetheless, financial and monetary policy tools can complement fiscal policies and help with mitigation efforts. All hands are needed on deck, for, as Mark Carney of the Bank of England has warned, "the task is large, the window of opportunity is short, and the stakes are existential."
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