Economic policy and climate change: Current practices and challenges for the ECB

Ettore Gallo and João Paulo Braga

Chapter 5 in Central Banking, Monetary Policy, and the European Central Bank, 2025, pp 99-118 from Edward Elgar Publishing

Abstract: Climate change demands an active climate policy combining private and public agents and different policy instruments. Central banks (CBs)are also acting, but there is still a controversy about whether climate mitigation should be a monetary policy mandate. Conventional economic models,such as the Taylor Rule, do not account for climate, while climate change might affect monetary policy effectiveness. In practice, central banks have already mobilized and are actively implementing a climate agenda, including the European Central Bank, which has already implemented climate risk measurement tools and enhanced management of fossil fuel asset portfolios. To study the impact of CB climate-related tools on the real economy, we present a stylized business cycle model to capture the interactions over the cycle between CO₂ emissions, output,and green and brown investment. We simulate the effect of higher interest rates and a reduction in green capital requirements. We find that higher interest rates might delay the shift towards green investment, while reducing green capital requirements can accelerate the transition. Accelerating the transition can protect economies from climate risks. However, side effects such as financial risks and inflation should be considered in policy decision-making.

Keywords: Green central banking; Climate change; European Central Bank; Capital requirements (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035324262
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