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ECB includes climate change in monetary policy strategy


Published: 21 September 2021

Overstromingen in Noord-Limburg

The ECB will incorporate climate change considerations in its new monetary policy strategy. To this end, the ECB has prepared an action plan setting out adjustments to macroeconomic modelling and statistics, to gain a better understanding of the impact of climate change on the economy and the financial sector.   Moreover, the ECB will explicitly consider the climate change risks inherent in its financial market operations, such as corporate bonds purchases.  The ECB will also disclose the climate change risks to which it is exposed. These measures send out an important signal for financial market participants to follow suit.

Climate change and climate policy affect the ECB's price stability objective

Governments have primary responsibility for climate policy. To meet this responsibility they have at their disposal instruments such as taxes on greenhouse gas emissions and climate investment schemes. Governments are also increasingly acting on climate change, prompted by initiatives such as the European Union's Green Deal.  Because of their impact on the economy and the financial system, climate change and climate policy are also relevant to the mandate of central banks.

Climate change and climate policy affect the ECB's price stability objective as they can both affect inflation. Prices of goods and services may fluctuate more sharply due to economic shocks resulting from climate change impacts like droughts or floods. Governments' climate policies, especially emissions taxes, also in principle affect price levels. In a scenario where governments are forced to raise emissions taxes abruptly, for example because they were initially too slow to react, prices could rise significantly. Such effects on inflation are uncertain, but central banks must have these risks on their radar, due to their price stability mandate.  That is why the ECB is adjusting its macroeconomic models and statistics to gain a better understanding of the impact of climate change on the economy and the financial sector.

Adjustments to asset purchase policy based on climate criteria

The ECB will also take into consideration the climate change risks inherent in its financial market operations. Asset purchase programmes are a key monetary policy tool in this respect. The action plan considers how to adjust the allocation of purchases under the Corporate Sector Purchase Programme (CSPP), based on climate criteria. On the basis of these criteria, the ECB can monitor companies' commitment to and compliance with EU legislation in implementing the Paris Agreement.  The amount of bonds the ECB purchases is currently still based on the outstanding amount of non-financial corporation debt in the capital market. As emission-intensive corporates are large and have considerable recourse to debt financing, they are also a relatively large component of the CSPP. As a result, in macro-economic terms the CSPP does not contribute to optimal distribution of capital in the economy.

Risk control measures

The action plan also contains specific measures for incorporating climate considerations in the ECB's risk control measures. Climate change has consequences for the value and risk profile of assets held on the central bank balance sheet. Climate shocks can lead to write-downs of government and corporate bonds in monetary policy portfolios, and can therefore impact central banks’ balance sheets. In addition, central banks must consider climate change and transition risks for the collateral submitted by banks to which they lend. After all, the credit quality of that collateral can deteriorate if these risks materialise. 

Under the action plan, the ECB will disclose the climate risks it is exposed to itself, primarily for corporate bonds under the CSPP and its investment portfolios. In addition, the ECB will make climate-related reporting a precondition for financial institutions' participation in monetary operations and for the qualification for purchase and eligibility (as collateral) of assets. The ECB is also studying the possibility of incorporating climate change risks in the collateral framework, by for example applying haircuts in the valuation of collateral that are aligned to these risks. The ECB will also integrate climate risks  in its own risk control framework by performing climate stress tests.

This article is the fourth and final in a series of DNBulletins on the ECB’s strategy review and addresses the role of climate change and climate policy on monetary policy.

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