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Economists: Central banks should adopt explicit net-zero strategies

Federal Reserve building

The U.S. Federal Reserve headquarters building in Washington, D.C. Image by Shutterstock/DCStockPhotography

Achieving net-zero emissions is the best way of minimizing the risks posed by climate change to the stability of the financial system, and central banks around the world should therefore all have explicit strategies to support the transition, a group of economists argue in fresh research released this week.

Well over half of global greenhouse gas emissions are covered by net-zero targets — including in countries and regions such as the U.K., EU and China — but many of these countries' central banks have yet to set out how they will ensure their activities are coherent with their governments' decarbonization policies, according to a study led by academics from the LSE and SOAS in London.

As part of the budget earlier this month, U.K. Chancellor Rishi Sunak announced plans to change the remit of the Bank of England's Monetary Policy Committee (MPC) to "reflect the government's economic strategy for achieving strong, sustainable and balanced growth that is also environmentally sustainable and consistent with the transition to a net-zero economy".

The move was broadly welcomed by campaigners, financiers and green businesses alike, amid long-standing concerns about the lack of joined-up thinking in support of the net-zero transition across the Bank of England's activities and decision making. Such concerns were heightened in the wake of the coronavirus crisis last year, when the Bank of England incurred criticism from green groups for offering loans and financial support to hard-hit companies in carbon-intensive sectors, such as airlines, without attaching "green strings" that would require firms receiving assistance to adopt decarbonization or risk disclosure targets.

As guardians of macroeconomic and financial stability, central banks and supervisors now need to introduce explicit strategies to support the transition to net-zero.

But this week's report — authored by economists Nick Robins, Simon Dikau and Ulrich Volz — goes further, arguing all central banks including the Bank of England, the Banque de France, the European Central Bank and the United States Federal Reserve System should have clear net-zero strategies in place to inform all their decision-making and activities going forward.

Central banks, the authors argue, need to "ensure that their activities are coherent with net-zero government policy" and "consistently integrate climate change into monetary frameworks and models to adequately account for the impacts of climate change on macroeconomic outcomes."

Specifically, it recommends investment practices for central banks' portfolios should include a net-zero target, and that they should each publish a transition plan to achieve the goal, while assessing the potential impacts of the green economic shift on livelihoods in order to draw up mitigation measures.

Moreover, it calls for the climate risk reporting guidelines for investors, organizations and businesses set out by the Taskforce on Climate-related Financial Disclosures to be strengthened in order to take better account of net-zero targets.

The study, jointly published by LSE's Grantham Research Institute on Climate Change and the Environment alongside the Centre of Sustainable Finance at SOAS, the University of London, said central banks held significant sway over whether the financial system helps drive the wider net-zero transition.

"As guardians of macroeconomic and financial stability, central banks and supervisors now need to introduce explicit strategies to support the transition to net-zero," the report concludes. "As more and more governments adopt net zero policies, prudential and monetary authorities will have a crucial role in translating financial sector leadership into universal practice across the financial system."

The research, funded by the European Climate Foundation, adds: "Markets respond to signals from central banks, and the seriousness of intent with which they consider net-zero targets is likely to have a profound bearing on financial market decisions that will ultimately determine capital formation and, thus, the carbon trajectory of the economy."

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