Federal Reserve won’t be ‘climate policy maker,’ says chair Powell

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The Federal Reserve is not interested in becoming a “climate policy maker,” chair Jerome Powell said Tuesday, arguing that the U.S. central bank needs to focus on its core mandate and guard its independence from political interference as it tackles persistently high inflation.

“We should stick to our knitting and not wander off to pursue perceived social benefits that are not tightly linked to our statutory goals and authorities,” Mr. Powell said in Stockholm at a symposium about central bank independence. The Fed is tasked by the U.S. Congress with maintaining price stability and maximum employment.

Monetary policy makers around the world have become increasingly involved in debates about climate change in recent years. Some economists and activists argue central banks should do more to help finance the transition to a low-carbon economy. Others warn of mission creep – that central bankers risk undermining the effectiveness of monetary policy if they stray beyond their relatively limited mandates.

The surge in inflation over the past year has raised the stakes. Central bankers have been criticized by politicians and the public for failing to maintain price stability. Now, as policy makers rapidly raise interest rates, they are becoming sensitive to potential risks to their independence.

“Restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy. The absence of direct political control over our decisions allows us to take these necessary measures without considering short-term political factors,” Mr. Powell said.

In 2020, the Fed joined the Network for Greening the Financial System, a group of central banks focused on climate issues. The move was criticized by Republican politicians. And last year, Republican senators blocked President Joe Biden’s nomination of Sarah Bloom Raskin to lead the Fed’s banking supervision team, because of her pro-active views on managing climate-related risks.

Most environmental policy is better handled by elected officials, Mr. Powell said Tuesday. But the Fed does have “narrow, but important, responsibilities regarding climate-related financial risks,” in its role as a bank supervisor, he said.

The Bank of Canada is taking a similar approach. In a separate panel discussion at the event in Stockholm, Governor Tiff Macklem said the Bank of Canada has “a role to play” in addressing climate change. But this is mainly through helping financial institutions understand and manage risks, rather than through lending or targeted interventions in financial markets.

“It’s really up to governments, elected officials, parliaments to set climate change policy,” Mr. Macklem said.

The Bank of Canada, alongside the Office of the Superintendent of Financial Institutions, worked with several large banks and insurance companies last year to assess their exposure to “transition risks,” which include higher carbon taxes and shifts in oil demand. Their portfolios also face physical risks tied to climate change, including the impact of increased flooding and wildfires.

“With so much uncertainty, we can’t predict the economic and financial system implications with any confidence. But what we can do is we can map out the implications of different climate scenarios,” Mr. Macklem said.

Other central banks have taken a more hands-on approach to supporting decarbonization efforts. In 2021, the European Central Bank began to “tilt” its corporate bond purchases toward companies with better climate performance, with the aim of lowering borrowing costs for environmentally-friendly issuers. The Bank of Japan, meanwhile, has provided around US$28-billion in loans to support low-carbon initiatives since 2021.

Even more pro-active central banks, however, are having to rethink their approach to climate as they tighten monetary policy, top central bankers noted at the Stockholm conference.

In 2021, the Bank of England began emphasizing greener companies in its corporate bond purchases. But it has since stopped buying corporate bonds altogether and has started actively selling them. This is to put upward pressure on interest rates in support of broader monetary policy tightening.

“We’re selling [corporate bonds] because my judgment is that’s the right thing to do from the point of view of monetary conditions,” Bank of England Governor Andrew Bailey said, speaking on the same panel as Mr. Macklem. “From the point of view of climate change, of course it might be better if we didn’t sell it. But actually, that’s not the primary objective.”

The ECB has also stopped buying corporate bonds, limiting one of the main tools it was using to support climate-related finance. ECB board member Isabel Schnabel said the central bank may consider “actively reshuffling” its bond portfolio toward greener issuers. But it is unlikely to launch a green lending program any time soon, she said, “given the current restrictive monetary policy stance.”

While the ECB has a mandate from the European Parliament to take climate change into account when conducting monetary policy, Ms. Schnabel said the most important thing right now is tackling inflation and restoring price stability.

“There is a concern that higher interest rates may discourage efforts to decarbonize our economies,” she said. “Does this imply that we should raise our interest rates less forcefully? My answer is clearly no, for a simple reason: The green transition can only thrive with price stability. High inflation is a tax on investment. It holds back investments by creating uncertainty and by distorting relative price signals.”