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Climate actions and macro-financial stability: The role of central banks

Francesca Diluiso, Barbara Annicchiarico, Matthias Kalkuhl and Jan C. Minx

Journal of Environmental Economics and Management, 2021, vol. 110, issue C

Abstract: Limiting global warming to well below 2 °C may pose threats to macroeconomic and financial stability. In an estimated Euro Area New Keynesian model with financial frictions and climate policy, we study the possible perils of a low-carbon transition and evaluate the role of monetary policy and financial regulation. We show that, even for very ambitious climate targets, transition costs are moderate along a timely and gradual mitigation pathway. Inflation volatility strongly increases for disorderly climate policy, demanding a strong monetary response by central banks. In reaction to an adverse financial shock originating in the fossil sector, a green quantitative easing policy can provide an effective stimulus to the economy, but its stabilizing properties do not significantly differ from those of market neutral asset purchase programs. A financial regulation, encouraging the decarbonization of the banks’ balance sheets via ad hoc capital requirements, can significantly reduce the severity of a financial crisis, but prolongs the recovery phase. Our results suggest that the involvement of central banks in climate actions must be carefully designed to be in compliance with their mandate and to avoid unintended trade-offs.

Keywords: Climate policy; Green transition; Monetary policy; Capital requirements; Green quantitative easing; Euro area (search for similar items in EconPapers)
JEL-codes: E50 H23 Q43 Q50 Q58 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jeem.2021.102548

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Journal of Environmental Economics and Management is currently edited by M.A. Cole, A. Lange, D.J. Phaneuf, D. Popp, M.J. Roberts, M.D. Smith, C. Timmins, Q. Weninger and A.J. Yates

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