Public stimulus delivered by central banks cannot entrench our existing carbon-intensive economic system. We must use the tools of fiscal and monetary policy to accelerate a green recovery.
Katie Kedward is a heterodox economist & freelance researcher
Cross-posted from the UCL IIPP Blog
Hopes of a V-shaped recovery from Covid-19 are fast diminishing. Recent data suggests that the economic consequences of the crisis are likely to last years, not months. US employment figures, the bellwether for global economic health, have reported over 38 million job losses in the past 9 weeks, far exceeding the 8.8 million unemployed during the 2008 recession. Many sectors, especially aviation and hospitality, are unlikely to recover to their pre-crisis size until a vaccine is found and administered — a process that could take years.
Given this reality, government support is vital to recovery. But who we bail out, and how, matters. Public bailouts do not just prop up productive capacity in the short term. They actively shape the economy for the long term.
The problem: bailouts have few conditions
A key concern is many companies benefitting from bailouts have unsustainable business models. Globally, 11% of fiscal stimulus packages, totalling some $840 billion, are supporting sectors that are damaging to the environment.
However, it is not just fiscal policy that will shape the economy of the future. Significant sums of public support are flowing to corporate sectors through monetary policy interventions. Both the $600 million Main Street Lending Programme in the US and the Covid Corporate Financing Facility in the UK offer financing to corporations with few conditions attached, even to maintain basic payrolls and salaries ahead of shareholder payouts.
Lack of conditionality within public support outs risks repeating the mistakes of the 2008 financial crisis, where stock markets and executives profited handsomely from public money. By financing large corporations, the Fed and the Bank of England could be viewed as acting as a fiscal arm of the government. These publicly owned institutions have a duty to ensure such public support yields benefits to society as a whole.
Central banks are not just aiding companies with short-term liquidity. They are also providing longer-term support by purchasing — with newly created money — companies’ bonds and short-term loan notes. The European Central Bank, Bank of Japan, and Bank of England have increased the scale and pace of their existing asset purchase programmes, whilst the Fed plans to inject up to $750 billion into the private sector. The assets eligible for purchase include several speculative markets, such as junk bonds, asset-backed securities, and private equity.
Distorting the energy transition
By deploying support without conditionalities, central banks are potentially interfering with the repricing effects of the energy transition. Previous rounds of corporate bond purchases have been disproportionately skewed towards carbon-intensive industries. The eligibility criteria imposed by central banks reflects a structural carbon bias within finance, where highly-rated companies with access to bond markets are often industrial incumbents with carbon-intensive business models.
For example, 50% of the Bank of England’s eligible bond universe today is comprised of electricity, industrials, transport, gas, and energy — despite those sectors contributing only 11.8% to UK Gross Value Added. In the US, the energy sector makes up 11% of the investment-grade corporate bond market, which means its stands to gain over $82 billion in public aid based on the Fed’s projected purchases.
At a time where carbon-intensive firms are increasingly feeling the heat from their own investors regarding the energy transition, such disproportionate support calls into question central banks’ claims of ‘market neutrality’. Central banks are at risk of becoming the ‘investor of last resort’, propping up firms that would otherwise have to evolve their business models. It is also unclear when, if ever, this ‘shielding effect’ will end. Central bankers have been hazy on how long they intend to hold corporate bonds for, and previous attempts to unwind asset portfolios have been thwarted by market tantrums.
Moreover, the financial assets of carbon-intensive sectors are vulnerable to ‘stranding’ as the impacts of climate change materialise. Such risks threaten financial stability if they cascade throughout the whole system — a fact now widely acknowledged by central bankers across the world. Before the Covid-19 crisis, Bank of England governor Andrew Bailey and his ECB counterpart Christine Lagarde were poised to exclude carbon-intensive bonds from asset portfolios, with Bailey highlighting that he considered it a “priority”.
It’s time for ‘green forward guidance’
The relaunch of asset purchase programmes without conditions represents a step backwards in the prudent management of climate risk. Central banks have a duty to ensure that asset portfolios take climate considerations into account. This is not ‘market interference’, as some critics might argue, but part and parcel to protecting price and financial stability.
To that end, central bankers must signal expectations on how their asset portfolios will be managed in the context of the energy transition. Firstly, the most carbon-intensive sectors, such as fossil fuels, should be excluded immediately. Secondly, ‘green forward guidance’ should signal that the proceeds of maturing central bank portfolios will be invested according to a green taxonomy. Under such conditions, polluting firms would only continue to receive support if they actively transition their business models. Tightening such requirements over time would promote a smooth and orderly energy transition.
Elsewhere, as corporates repay short-term loans to central banks, the proceeds should be redeployed to support green investment and innovation — for example, via the capitalisation of public investment banks dedicated to environmental financing. These funds were created by central banks to fulfil a public purpose, and such public money must continue to benefit society directly.
In the wake of the Covid-19 crisis, central banks around the world have seen their mandates extended far beyond their traditional remits of inflation control. In their capacity as ‘investor of last resort’ to the private sector, recent central bank policymaking has been characterised more by its cooperation with Treasury departments than operational independence. At the current juncture, where the private sector is becoming increasingly indebted, such fiscal-monetary coordination is arguably the only strategy to avoid the worst effects of a balance sheet recession.
At the same time, public stimulus delivered by central banks cannot entrench our existing carbon-intensive economic system. As environmental breakdown renders our planet increasingly uninhabitable, the failure to use the tools of fiscal and monetary policy to accelerate a green recovery would be an enormous missed opportunity. Covid-19 will not be the last major shock to threaten society. We much ensure these unprecedented central bank interventions help shape a better world for tomorrow.