As the Chancellor makes his statement on government spending, all eyes are on fiscal policy, including announcements on the Government’s Green Recovery plans. The implications of the monetary response, however, should not be overlooked, writes Ira Poensgen.
Fighting fire with fire may sometimes be an effective strategy. Fighting a fire by setting a planet aflame, however, lies somewhere in between short-sightedness and downright lunacy. Yet in many ways, this describes the current monetary policy response to Covid-19 startlingly well.
For central banks’ programmes purchasing corporate bonds on a large scale are biased in favour of carbon intensive sectors, actively undermining urgently needed climate action – a Faustian pact indeed.
The coronavirus pandemic has been a major shock to economies, creating unprecedented challenges to policymakers around the globe. As the Chancellor makes his statement on government spending, all eyes are on fiscal policy, including announcements on the Government’s Green Recovery plans. The implications of the monetary response, however, should not be overlooked. The manner in which monetary policies are being implemented by the European Central Bank (ECB) and the Bank of England (BoE), risk creating a dangerous trade-off between a Covid-19 recovery and the low-carbon transition. For the current corporate bond purchase programmes exhibit a stark structural bias in the opposite direction.
Corporate bond purchases have become a popular instrument in the toolbelt of central bankers.
They form part of a broader group of Quantitative Easing (QE) policies that rose to prominence in the wake of the 2008 financial crisis[i]. Stated simply, central banks that were hobbled by a macroeconomic environment that caused their conventional policy tools to fail began to directly purchase financial assets in secondary markets, aiming to boost money supply and encourage lending[ii]. Different jurisdictions prioritized the purchase of different assets, producing varying flavours of QE. In Europe, both the BoE and, more recently, the ECB have included significant corporate bonds purchase programmes (CBPPs) as part of broader QE packages.
In theory, such programmes should be “market neutral”. As long as central banks purchase a balanced portfolio of corporate bonds, so the argument goes, their activities should not alter the relative prices of assets[iii]. Both the ECB and the BoE stress that their programmes are explicitly designed to reach this goal of market-neutrality[iv]. In practice, it is less than clear that this is achieved. Already in 2016, research highlighted the potential distributive effects of CBPPs and showed that bonds included in QE programmes by central banks generally performed significantly better than comparative bonds that were excluded. This has an important implication: corporations whose bonds are bought by central banks will likely face a lower cost of borrowing than those that are not.
So why does this matter for the climate? In 2017, the Grantham Research Institute (GRI) analysed the CBPPs of the ECB and the BoE, and evaluated their impact on the low-carbon transition[v]. They found that the purchases of both institutions exhibited a significant skew towards carbon-intensive sectors such as utilities, manufacturing and transportation. This is even more visible when comparing the share of central bank purchases in these sectors, to the sectors’ contribution to the overall Eurozone economy. Chemical and petroleum products, for example, account for less than 1% of gross value added, but feature prominently in CBPPs[vi].
In part, this may simply reflect that the bond-market does not accurately mirror the economy. As of today, there are few existing “climate-aligned” bonds and the overall market is skewed towards emission-intensive industries. This limits the options available to central banks. However, the GRI analysis also demonstrated that this skew is compounded by the fact that the BoE and the ECB only deem a part of the bond market eligible for purchase. In short, the eligibility criteria further benefit large incumbents in carbon-intensive sectors, whilst low-carbon assets remain under-represented.
The problem is coming into sharp focus now. In response to the pandemic, central banks are stepping up their QE activities. Earlier this year, both the ECB and the BoE announced significant expansions of their purchasing activity, part of which will focus on corporate bonds[vii]. Early investigations by the New Economics Foundation and several UK universities have shown that the carbon bias of earlier purchase programmes persists.[viii]
Ironically, this comes at a time where central banks around the world are beginning to push for regulatory action to ‘green’ the financial system. The BoE is associated with an international leadership role in this discussion. Yet this priority is not reflected in its own policies and balance sheet.
Since the early days of the pandemic, activists, business leaders, researchers and other commentators have continuously emphasised that Covid-19 recovery packages provide a chance to contribute towards the de-carbonization of our economy [ix]. In these discussions, the impact of monetary stimulus packages is being overlooked. Central banks should lead by example to show how climate considerations can be mainstreamed in investment decisions. This would not only help stimulate a much-needed green recovery, but also signal to financial market participants that climate is an issue that can no longer be ignored.
[i] Andrea Zaghini, ‘How ECB Purchases of Corporate Bonds Helped Reduce Firms’ Borrowing Costs’, European Central Bank (blog), 28 January 2020, https://www.ecb.europa.eu/pub/economic-research/resbull/2020/html/ecb.rb200128~00e0298211.en.html.
[ii] Michael Joyce et al., ‘Quantitative Easing and Unconventional Monetary Policy – an Introduction’, The Economic Journal 122, no. 564 (1 November 2012): F271–88, https://doi.org/10.1111/j.1468-0297.2012.02551.x.
[iii] Sini Matikainen, Emanuele Campiglio, and Dimitri Zenghelis, ‘The Climate Impact of Quantitative Easing – Policy Paper’ (Grantham Research Institute on Climate Change and the Environment, 2017).
[iv] BoE, ‘Monetary Policy Summary for the Special Monetary Policy Committee Meeting on 19 March 2020’, Bank of England, 19 March 2020, http://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2020/monetary-policy-summary-for-the-special-monetary-policy-committee-meeting-on-19-march-2020; ECB, ‘Pandemic Emergency Purchase Programme (PEPP) – Q&A’, European Central Bank, 2 April 2020, https://www.ecb.europa.eu/mopo/implement/pepp/html/pepp-qa.en.html.
[v] Matikainen, Campiglio, and Zenghelis, ‘The Climate Impact of Quantitative Easing – Policy Paper’.
[vi] Matikainen, Campiglio, and Zenghelis.
[vii] ECB, ‘ECB Announces €750 Billion Pandemic Emergency Purchase Programme (PEPP)’, European Central Bank, 18 March 2020, https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1~3949d6f266.en.html; BoE, ‘Monetary Policy Summary for the Special Monetary Policy Committee Meeting on 19 March 2020’.
[viii] Yannis Dafermos et al., ‘Decarbonising the Bank of England’s Pandemic QE’, New Economics Foundation, August 2020, 18; Yannis Dafermos et al., ‘Beyond Market Neutrality in the ECB’s Corporate QE’, New Economics Foundation, October 2020, 25.
[ix] ‘Building Back Better: Green COVID-19 Recovery Packages Will Boost Economic Growth and Stop Climate Change | University of Oxford’, accessed 13 November 2020, https://www.ox.ac.uk/news/2020-05-05-building-back-better-green-covid-19-recovery-packages-will-boost-economic-growth-and.