The prices of the ingredients of a pizza margherita rose more than twice as fast as the total inflation in Italy in July: 13.5 versus 5.9 percent on an annual basis, so reported Bloomberg news agency recently. Mozzarella, tomatoes, pizza dough, it all became considerably more expensive. Olive oil takes the crown: it rose in price by 30 percent.
Olive oil from southern Europe has become more expensive mainly due to disappointing harvests – a result of the extreme heat and drought that has plagued the south of the continent since spring. In the 2022-2023 harvest year, olive oil production in the EU will be 35 percent lower than the average of the past five years, the European Commission expects. The scarcity pushes prices up.
It is an example of ‘climate inflation’: climate change that contributes to price increases. Although extreme weather cannot simply be attributed to climate change, global warming makes heat waves and droughts much more likely.
‘Climate inflation’ has quickly entered the radar of central banks: they must take it into account in their inflation models. Last year, European Central Bank economists calculated that the summer heat and drought already increased inflation by 0.33 percentage point, and this effect is expected to increase in the coming years. The central bank aims for 2 percent inflation in the medium term.
It is therefore striking that the theme of climate has been compromised in a different way at the ECB. With the central bank’s ambition to contribute to the fight against climate change itself, things are not going to go smoothly.
Green Lagarde
The theme of climate is “critical to the central bank’s mission”, said ECB chief Christine Lagarde when she took office at the end of 2019. Not only should the ECB, as bank supervisor, pay closer attention to how climate risk affects the bank balances. The ECB should also green its own monetary policy by including climate criteria, said Lagarde and ECB colleagues. Because the ECB is such a powerful player on the financial markets, it should pull the financial system as a whole towards greening.
The US central bank believes that climate policy is only a matter for elected politicians
With that, the ECB took a position in a fraught debate among central bankers and economists. The US central bank, the Fed, believes that climate policy is solely a matter for elected politicians and that it itself has no mandate to do so (apart from the climate monitoring of banks, which the Fed has now taken up). The ECB sees this differently. She acknowledges that politics has the main responsibility to reduce emissions, but also believes that as an EU institution she cannot avoid the Paris climate goals. The ECB is not alone in thinking this way. The Bank of England and the Bank of Japan are also integrating the climate into their monetary policy.
Specifically, the ECB decided to take two steps last year. First, the corporate bond purchases it conducts have been brought more in line with climate criteria from October 2022. Companies with low emissions and verifiable climate plans were preferred over dirty companies. According to the ECB, there is enough data to cheat criteria (greenwashing) by companies.
Secondly: the collateral that banks have to deposit with the ECB when they borrow money – often these are also bonds – must also meet climate requirements. Among other things, it may only come to a limited extent from companies with a large CO2footprint. These measures should only come into effect from the end of 2024, because data and legislation are currently insufficient.
Hardly any climate policy
But while that second step is still pending, the first one is already failing. Because the purchase of corporate bonds has now virtually come to an end. This means that the most important instrument for making the ECB’s policy greener has virtually disappeared.
This has to do with the sharp rise in inflation in the eurozone. The purchase of corporate bonds, which started in 2016, was intended to boost inflation, which was too low at the time – it was below 2 percent for years. By buying corporate debt, the ECB reduced their borrowing costs. But now inflation is much too high and the ECB is trying to tame it with a more stringent monetary policy: higher interest rates, no more government and corporate bond purchases. Corporate bond purchases were halted in July 2022.
The ECB hardly pursues any green monetary policy anymore, despite all its ambitions
The previously purchased bonds that expired were first replaced by new ones (‘reinvested’), but since last month this has no longer happened for the lion’s share of the bonds already purchased (only 45 billion of the total of 380 billion is still being reinvested). .
In short, the ECB hardly pursues any green monetary policy anymore, despite all its ambitions. The ECB itself admits that there is a problem. The greening of the ECB balance sheet is being “substantially delayed,” said influential ECB executive Isabel Schnabel in January this year in a speech.
What now? To act in line with ‘Paris’, the ECB needs to do more, Schnabel said. She proposed to “actively” green the mountain of previously purchased corporate bonds of now 380 billion euros. The ECB would then have to sell ‘dirty’ loans and buy new, cleaner ones. A look at the ECBbond register immediately shows a few possible candidates for sale: Shell and Total, two oil companies that are actively looking for new oil sources.
Schnabel offered a few more ideas. For example, the ECB can actively replace previously purchased government bonds on the balance sheet with more ‘green’ government bonds, intended for climate projects. There are not that many of the latter, but one option is, for example, the purchase of more green (semi-) government bonds from institutions such as the European Investment Bank.
‘Promises broken’
More than half a year later, nothing of Schnabel’s proposals has come to fruition. Environmental organization Greenpeace concluded in a report last month that the ECB has “broken” its “promises” to act in line with the Paris Agreement. Lagarde said in her most recent press conference late last month that the Paris accord still serves as a guideline and that the ECB will determine “over the course of 2023” how to continue pursuing climate policy at a time of high inflation.
The ECB is increasing inflation risks in the longer term, that is incomprehensible
Jens van ‘t Klooster researcher UvA
Jens van ‘t Klooster, philosopher and political economist affiliated with the University of Amsterdam and specialized in central banks, sees a lot of resistance within the 26-member ECB board against actual greening of the policy. In addition to proponents, such as Lagarde, Schnabel and Dutch board member Frank Elderson, there are also skeptics, including the chairmen of the central banks of Germany and Belgium, who fear that the theme of climate will distract from the central mission of the bank: price stability.
“A lot has changed in a short time at the ECB in thinking and in statements about the climate. But what the ECB is doing is insufficient,” said Van ‘t Klooster by telephone. He finds it “disappointing” that the ECB has not made much more progress in greening bond purchases. But he is mainly concerned about something else: the central bank’s interest rate hikes, intended to bring back inflation, are jeopardizing investments in the energy transition.
The ECB raised interest rates very quickly: the main rate went from minus 0.5 to 3.75 percent in just over a year. This affects projects in the energy transition “disproportionately”, says Van ‘t Klooster. “The investment costs for wind turbines, solar energy and making buildings more sustainable are relatively high and are very sensitive to interest rates. In the longer term, the costs are lower and also more stable than with fossil fuel projects, but you have to make those investments first.”
Read also: Climate policy expensive? It generates tens of thousands of billions, says the IMF
Green interest discount
The ECB can – and must, according to Van ‘t Klooster – intervene by giving banks that provide credit for the energy transition an interest rate discount. The ECB itself has been thinking about such a green interest rate discount for some time, but believes that such a step is not an option now, because to tame inflation, interest rates must go up, not down.
With this ‘short-sighted’ way of thinking, the central bank is shooting itself in the foot as an inflation fighter, believes Van ‘t Klooster. In his view, the ECB interprets its price stability mandate rather narrowly as: inflation of 2 percent, to be achieved within a period of about two years. The central bank fails to think about price stability in the longer term, he says. Last year’s wave of inflation was mainly due to peak prices for fossil energy, and recently it has mainly been due to rising food prices, with global warming playing a role. The ECB should try to prevent this kind of fossil energy and climate inflation in the future, says Van ‘t Klooster. “The ECB wants to fight inflation with high interest rates, but increases inflation risks in the longer term. That is inconceivable.”
Giving an interest discount on credit for sustainable projects is quite possible, says Van ‘t Klooster. The central banks of Japan, China and Malaysia have already opened green lending counters. And the idea of varying interest rates is not new in Europe either, the researcher found in the archives of national central banks.
In earlier periods of rising inflation, in the 1970s and 1980s, the German Bundesbank, the Banque de France and De Nederlandsche Bank raised interest rates – but made exceptions for credits for export promotion. This is because more exports were good for the exchange rate of the currency (mark, franc and guilder). This reduces inflation, because imports then become cheaper. Van ‘t Klooster: “At that time, as now, there were good arguments for varying interest rates. Also monetary arguments. In any case, it is not an out-of-the-box idea.”
A version of this article also appeared in the August 18, 2023 newspaper.