Blog Post

A brown or a green European Central Bank?

The European Central Bank portfolio is skewed towards the brown economy, reflecting a bias in the market. Can and should the bank deviate from the market allocation?

By: Date: February 24, 2021 Topic: Energy & Climate

Climate change is a hotly debated issue in the European Central Bank’s ongoing strategy review. While ECB president Christine Lagarde and her colleagues at the centre favour robust tools to tackle climate change, most national central bank governors (like their colleagues at the US Fed) seem to be against including climate considerations in monetary policy. The core question is: should the ECB continue to accommodate the bonds and bank loans of carbon-intensive companies as assets or collateral, or should it reduce them?

Facts

In its quantitative easing programme, the ECB buys corporate bonds in proportion to their availability on the market. Carbon-intensive companies, such as oil and gas companies and car manufacturers, are typically also capital intensive and thus issue more corporate bonds. By taking assets proportional to the market, the ECB’s asset portfolio is skewed towards high-carbon companies relative to low-carbon companies. The carbon intensity (defined as carbon emissions divided by sales) of the ECB’s corporate bond portfolio is 57 percent higher than the average carbon intensity of EU companies. This large carbon bias makes the ECB a brown central bank.

By accommodating high-carbon corporate bonds, the ECB improves the liquidity of these bonds (just as it improves the liquidity of low-carbon companies’ bonds) thereby lowering the cost of capital for high-carbon and low-carbon companies equally.

Mandate

Could the ECB address its carbon bias? There are broadly speaking three routes. First, the ECB’s primary mandate is price stability. If the ECB does establish that climate change has an impact on future inflation (eg through rising food prices due to droughts), it should be vigilant and prepare an appropriate monetary response to ease potential inflation pressures. Although the inflation impact of climate change seems to be remote, it is already part of the ECB’s monetary policy work to monitor this. Moreover, better modelling of the climate risk impact on monetary policy does not address the carbon bias in the ECB’s monetary policy operations.

Second, the ECB’s legal mandate states that it “shall support the general policies in the EU, without prejudice to price stability”. This refers to the ECB’s secondary goals. The transition to a low-carbon economy is a cornerstone of the EU’s general economic policies. The European Green Deal has a target of curbing carbon emissions by at least 55% by 2030.

The ECB can support the EU’s climate policy by cutting carbon emissions in its asset and collateral portfolio for monetary policy purposes. This second argument is the most compelling, especially were the European Parliament and Council to declare that the EU’s climate policy has priority within its general economic policies over the next decade(s).

Third, the ECB could include a climate risk assessment in its monetary policy operations. High-carbon companies are more exposed to rising carbon taxes, which increases the risk of write down for these companies. The haircut on collateral of high-carbon companies can then be increased. Again, risk assessment is already included in the ECB’s collateral framework. Moreover, climate risk is a major issue for the ECB’s supervisory and financial stability tasks. A climate stress test of the Dutch banking sector, for example, indicated that losses could amount to 4%-63% of core capital for a €100 to €200 per ton carbon tax.

In sum, the climate change debate in monetary policy is first and foremost about the ECB’s allocation of monetary reserves to high-carbon companies. The question is then which approach could reduce this allocation?

Tilting

There are several ways to reduce the over-allocation to high-carbon companies. These range from excluding the most carbon-intensive companies or dealing exclusively with low-carbon companies to tilting the portfolio towards low carbon. We developed a methodology to tilt the asset and collateral base for monetary policy operations towards low-carbon assets. For assets, tilting would relate the relative share of a company’s securities inversely to its carbon intensity. The ECB would then over-weight low-carbon companies and under-weight high-carbon companies in its asset portfolio. For collateral, an additional haircut could be directly related to carbon intensity. The ECB would then apply an additional haircut to high-carbon assets in its collateral framework.

A medium tilting approach can reduce carbon emissions in the central bank’s corporate and bank bond portfolio by over 50%, offsetting the current carbon bias. Our paper shows how this can be done without unduly interfering in the smooth conduct of monetary policy. A key element of a tilting approach would be that the ECB would remain present in the entire market for eligible assets, which guarantees that monetary policy gets into “all of the cracks” of the economy. Tilting only increases the share of low-carbon assets at the expense of high-carbon assets, but does not exclude high-carbon assets.

So, a first step in tilting would turn the ECB from a brown central bank into a carbon-neutral central bank. A follow-up step could turn the ECB into a green central bank, aligned with the EU’s emission reduction targets.

Concluding

If the ECB were to take on the challenge of greening its monetary policy operations as a secondary goal, it would be of utmost importance to do it fully independently. The ECB could adjust the eligibility criteria for assets and collateral in a general way, using a transparent and objective indicator, such as carbon emissions. The ECB should refrain from favouring specific projects or setting sectoral targets, which are issues for government policy.

Recommended citation:

Schoenmaker, D. (2021) ‘A brown or a green European Central Bank?’, Bruegel Blog, 24 February


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Apr
20
14:00

Taking stock of global sustainability reporting

This closed-door event will discuss standards for the measurement and disclosure of climate-related exposures.

Speakers: Carole Crozat, Sonja Gibbs, Piers Haben, Lucile de la Jonquière, Alexander Lehmann, Sara Lovisolo, Fayyaz Muneer and Lee White Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic
 

Blog Post

China has a grand carbon neutrality target but where is the plan?

China’s new long-term targets, to reach peak emissions before 2030 and achieve carbon neutrality by 2060, are yet to be matched with a consistent short-term action plan.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Energy & Climate Date: April 14, 2021
Read article More on this topic More by this author
 

Opinion

More Europe or less Europe?

Europe is often a ship with multiple captains. The boat moves forward in calm seas, but when the slightest wind puts it off course, it is not easy to steer that boat. It is not so much a question of more Europe rather than less, but of achieving ‘one Europe’. A ‘more-or-less Europe’ is an invitation to go nowhere.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: April 14, 2021
Read about event More on this topic
 

Past Event

Past Event

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: European Macroeconomics & Governance Date: April 13, 2021
Read article More on this topic More by this author
 

Opinion

It’s time for a green social contract

The green transformation will have far-reaching socio-economic implications. Action is needed to ensure domestic and international social equity and fairness.

By: Simone Tagliapietra Topic: Energy & Climate Date: April 12, 2021
Read about event
 

Upcoming Event

Apr
29
14:00

The External Dimension of the EU's Green Deal: What Role for EU Development Cooperation?

The EU Green Deal's political scope extends far beyond climate neutrality and the European Union. What geopolitical and human repercussions does it have for its partners?

Speakers: Francisco André, Mikaela Gavas, Njuguna Ndung'u and Simone Tagliapietra Topic: Energy & Climate, Global Economics & Governance
Read article More on this topic More by this author
 

Blog Post

How to extend carbon pricing beyond the comfort zone

Rapid emission cuts need a carbon price for the whole economy. This must be introduced in careful stages. 

By: Georg Zachmann Topic: Energy & Climate Date: April 1, 2021
Read article Download PDF More on this topic
 

Policy Contribution

Navigating through hydrogen

Policymakers must address the need to displace carbon-intensive hydrogen with low-carbon hydrogen, and incentivise the uptake of hydrogen as a means to decarbonise sectors with hard-to-reduce emissions.

By: Ben McWilliams and Georg Zachmann Topic: Energy & Climate Date: April 1, 2021
Read article More on this topic
 

Blog Post

How has COVID-19 affected inflation measurement in the euro area?

COVID-19 has complicated inflation measurement. Policymakers need to take this into account and should look at alternative measures of inflation to understand what is actually happening in the economy.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: European Macroeconomics & Governance Date: March 24, 2021
Read article More on this topic
 

External Publication

Form a climate club: United States, European Union and China

If the three biggest economies agree a carbon tax on imports, it will catalyse climate action globally.

By: Guntram B. Wolff and Simone Tagliapietra Topic: Energy & Climate Date: March 23, 2021
Read about event More on this topic
 

Past Event

Past Event

Think green act local: the role of the G20 in sustainable infrastructure

In this workshop, invited guests will discuss priorities and proposals for the Italian G20 Presidency for a green local infrastructure agenda.

Speakers: Amar Bhattacharya, Marco Bucci, Adriana Calderon, Maria Demertzis, Matthias Helble, Elly Schlein, Niclas Poitiers and Gelsomina Vigliotti Topic: Energy & Climate Date: March 15, 2021
Read article More on this topic More by this author
 

Opinion

Central banks don’t have to pick winners and losers to fight climate change

Disclosures and financial regulation don’t get enough respect as tools to reduce emissions.

By: Rebecca Christie Topic: Finance & Financial Regulation Date: March 11, 2021
Load more posts