Last week I was pretty critical of the ECB's move to expand its mandate to take on climate policy. The ECB is not alone however. The Bank of England started down this direction. The IMF has also been a proponent, and the BIS is nodding assent. In short, the move that central banks, financial regulators, and ...
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Last week I was pretty critical of the ECB's move to expand its mandate to take on climate policy. The ECB is not alone however. The Bank of England started down this direction. The IMF has also been a proponent, and the BIS is nodding assent.
In short, the move that central banks, financial regulators, and their club of international institutions should to expand to general macroeconomic and financial dirigisme, and then take on climate, inequality, and other social causes far beyond their institutional mandates is widespread. The ECB is not alone, and in this context their wish to join the movement makes more sense.
I adapt here some comments I made last March at the end of the Homer Jones talk I gave at the Federal Reserve Bank of St. Louis (video, written version). For that reason my links and sources stop around then. All of that was quickly overshadowed by covid, but perhaps it's time to revive the question. Let's go:
From probity to exchange rate, capital, and macro prudential dirigisme.
For decades the IMF served a valuable function. IMF urged countries to keep trade and capital open. In a crisis, the IMF required a commitment to micro deregulation, cutting subsidies, and getting the fiscal house in order before offering a bridge loan. This is like borrowing from your grumpy uncle: Get a job, stop drinking and gambling, here is some money to tide you over, but I'll be watching.
In 2012, the IMF moved to an "institutional view," advocating that central banks "manage" capital flows and exchange rates, along with extensive macroprudential direction. For example, explaining the "institutional view," the IMF writes in 2018
"CFMs …are designed to limit capital flows. These can include administrative and price-based restrictions on capital flows, for instance bans, limits, taxes, and reserve requirements."
The BIS (2019) Annual Report Chapter II chimes in enthusiastically as well.
..most EME [Emerging Market Economy] ..inflation targeters have pursued a controlled floating exchange rate regime, using FX intervention to deal with the challenges from excessive capital flow and associated exchange rate volatility. This contrasts with standard textbook prescriptions for inflation targeters, which advocate free floating without recourse to FX intervention.
The IMF and BIS reports make clear that they are following emerging common practice at central banks around the world, rather than leading a new agenda. Whether jumping in front of a bandwagon is wise is a good question to ask. If the ambitious but vague dirigisme of these reports drives you batty, I recommend re-reading Lucas (1979) review of a previous OECD report, always a good tonic if you are suffering a deficit of grumpiness. See also the IMF's 2013 case for macro prudential policy
The IMF's new "integrated policy framework" promises an even more ambitious "integrated" approach to "monetary policy, macroprudential policy, exchange rate interventions, and capital flow measures," tailored to disparate "country circumstances." (Kristalina Georgieva, Financial Times, February 17, 2020.)
It is all very tempting. Central bankers like to feel important. Interest rates are either stuck at zero or don't seem to do a heck of a lot. Well, take on broad new powers to run things and do good as you see it. Alphabet soup international institutions are even less directly powerful. Well, cheerlead for the movement.
But like discretionary monetary policy, central banks have never been able to time credit and asset price cycles, or micromanage dozens of interacting policy levers to offset poorly understood (and country-specific) "frictions" and "imperfections," as the IMF now proposes and recommends. How do you tell a boom from a bubble in real time? How and why will central banks get it right this time after so many abject failures—2007 being the most recent and screaming example? How will they avoid repeating the endless problems of managed exchange rates and extensive capital controls that finally blew up in the 1970s? Central bankers are only human, just like the rest of us—and just as prey to the fallacy that we're the smart ones and everyone else is behavioral. In the crisis, as monetary policy committees were begging banks to lend, regulators were telling banks to cut back lest the crisis get worse. In the 12th year of the subsequent expansion, the U.S. was been if anything loosening capital and credit standards, despite great increases in credit. So much for macroprudence.
Rather than try to stop anyone from ever borrowing too much or losing money ex post, we should make the financial system robust so that people can make and lose money without burning down the house. That's the equity-financed banking approach.
The current trend is even more ambitious. Now, the International Monetary Fund, the Bank for International Settlements, and the Financial Stability Board are advocating and the Bank of England is starting to implement climate policies. Central banks should demand extensive disclosures of "climate risk" and contributions to "sustainable investing." Those lending to, say, fracking companies will have an army of regulators descend on them. The European Central Bank is buying "green" bonds. Fed Chair Jay Powell has so far been a courageous and principled resister to the climate side of this movement, ("Bankers Aren't Climate Scientists, WSJ 2020) but we'll see how long that lone voice of resistance can hold out.
BIS: See, for example, Bolton et al. (2020) "The Green Swan" at the BIS, whose abstract states central banks should step up to
"coordinating actions among many players including governments, the private sector, civil society and the international community. … Those include climate mitigation policies such as carbon pricing, the integration of sustainability into financial practices and accounting frameworks …"
In his foreword to this piece, BIS general Manager Augustín Carstens starts reasonably by also advocating carbon taxes—though this has nothing to do with central banks under usual readings of their mandates. But, since carbon taxation "requires consensus building" and is "difficult to implement," central banks should plow forward to
"raising stakeholders' awareness and facilitating coordination among them. Central banks can coordinate their own actions with a broad set of measures to be implemented by other players (governments, the private sector, civil society and the international community) …there are many practical actions central banks can undertake (and, in some cases, are already undertaking). They include… environmental, social and governance (ESG) criteria in their pension funds; helping to develop and assess the proper taxonomy to define the carbon footprint of assets more precisely (eg "green" versus "brown" assets); working closely with the financial sector on disclosure of carbon-intensive exposure…; …examining the adequate room to invest surplus FX reserves into green bonds. "
In a separate preface, François Villeroy de Galhau, Governor of the Banque de France, advocates that
"more holistic perspectives become essential to coordinate central banks', regulators', and supervisors' actions with those of other players, starting with government."
Bank of England:
Carney (2019) "fifty shades of green" is a good place to start. The first step is "disclosure." The FSB instigated a "task force on climate-related financial disclosures" (TCFD):
"four-fifths of the top 1,100 Group of Twenty companies now disclose climate-related financial risks as some TCFD recommendations advise. "
The next step is to make disclosure mandatory, as the United Kingdom and European Union have already signaled. The third step is regulation and de-financing unpopular industries:
"Banks …are taking steps to assess exposure to transition risks in anticipation of climate action. This includes exposure to carbon-intensive sectors, consumer loans for diesel vehicles, and mortgages for rental properties, given new energy efficiency requirements."
The message is clear: Nice bank you've got there. It would be a shame if something should happen to it. Sure you want to keep lending to fossil fuel companies?
"The Bank of England is …setting out our expectations with respect to the following:
Governance: Firms will be expected to embed the consideration of climate risks fully into governance frameworks, including at the board level…
Risk management: Firms must consider climate change in accordance with their board-approved risk appetite…
Appropriate disclosure of climate risks: Firms must develop and maintain methods to evaluate and disclose these risks.
The Bank of England will be the first regulator to stress-test its financial system under various climate pathways…This stress test will.. make the heart of the global financial system more responsive to changes to both the climate and to government climate policies.
The Bank of England will develop the approach in consultation with …other informed stakeholders, including experts from the Network of Central Banks and Supervisors for Greening the Financial System.…"
(Yes, my quotations are selective, so you can see what's going on in the otherwise sleep-inducing verbiage. Read the originals if you're unhappy about that.)
On to inequality.
The IMF is now advocating, along with climate, a full range of policies including increased "social spending," progressive taxation, income redistribution, and social-justice policies far beyond anything traditionally monetary or financial.
The IMF is now advocating, along with climate, a full range of policies including increased "social spending," progressive taxation, income redistribution, and social-justice policies far beyond anything traditionally monetary or financial. For example, IMF Managing Director Kristalina Georgieva (2020) writes in "Reduce Inequality to Create Opportunity,"
Progressive taxation is a key component of effective fiscal policy…Gender budgeting is another valuable fiscal tool in the fight to reduce inequality….The ability to scale up social spending is also essential…Active labor market policies…job search assistance, training programs, and in some instances, wage insurance….Geographically-targeted policies and investments can complement existing social transfers…:
During the implementation of the IMF-supported program, Egypt more than doubled its coverage of cash transfers,…we are working to implement our social spending strategy by weaving it into the fabric of our work…
Note the latter point -- during the implementation of the Egypt program... In the past, when the IMF parachuted in to a bankrupt country, the first thing it would do is to tell the government to rein in useless subsidies and other spending programs. When you look at a typical EME budget, they spend money on a lot of politically popular but ineffective subsidies. Many of them subsidize gasoline, not a great climate policy. Now the IMF is going to reverse that -- on inequality grounds, have a Bloody Mary for that debt hangover. And spend more money on green subsidies too. [Update: A correspondent inquires what "gender budgeting" means. It is a new euphemism to me
The IMF (2019) "Strategy for Engagement on Social Spending" goes into details.
…concerns about rising inequality and the need to support vulnerable groups,… a global commitment to continue support for inclusive growth, as expressed in the 2030 Sustainable Development Goals (SDGs).… Social spending is viewed as a key policy lever for addressing these issues.
The Fund has concomitantly increased its work on social spending. …The growing emphasis on inclusive growth is also reflected in operational activities, including the use of social spending "floors" in IMF-supported programs. There has been enhanced engagement on inequality issues in surveillance, as well as increased technical assistance to expand fiscal space for social spending.
Requirements for "sustainable accounting" (see Finley, 2020 WSJ, criticizing a Michael Bloomberg proposal), "disclosure" of environmental, social, and corporate governance (ESG) blessings, "stakeholder capitalism," divestiture, and de-financing more unfavored industries are already being advanced.
The messenger not the message
I emphasize that my objection here is to the messenger, not the message. These institutions are empowered to worry about financial affairs. They are not empowered, nor competent as general purpose do-good agencies.
There is a reasonable risk that climate change may be, in 50 or 100 years, a big economic problem. There is a larger risk that climate change is an environmental problem with little economic impact. But the risk that unforeseen changes—risk—in climate threatens the financial system with another run is essentially zero on the 5-year-or-so timeline of honest risk assessment. (Except maybe risks induced by the same regulators!)
Repeating the contrary assertion over and over in speeches does not make it so. That, say, coal company stock investors may lose money when regulators shut down their businesses is not a systemic risk, unless we debase "systemic" to mean anyone ever losing money on anything.
Likewise, you may regard inequality as a big economic problem. (I regard lack of opportunity as a big economic problem, but I'm more focused on compassion for the unfortunate than hatred of the super-rich.) But no matter how you feel about the issue, bringing inequality into the financial mandate by claiming that inequality causes systemic runs, as the IMF is doing, is a similar flight of fancy. And once you cook the books to advance climate and inequality, the books are cooked for everything else, too. And when the IMF comes flying in to solve a genuine crisis, everyone knows "here come the book-cookers, everything they say is going to be political.
As I write, (this was late Feb 2020) the chance of a systemic crisis induced by a pandemic is a strong possibility. That none of this scenario-building and stress-testing even considered pandemic risk, in the wake of SARS, MERS, Ebola, and HIV, exposes just how much groupthink and virtue-signaling and how little quantifiable prescience any of this effort has—and how utterly this whole project for a regulatory elite to foresee risk has failed. The possibility of advanced country sovereign default is similarly absent from these exercises, though it has happened many times before and would be a calamity to our system built on the sanctity of such debt and its ability to bail others out in crisis.
In sum, my objection has nothing to do with the importance or not of climate and inequality or the worthiness or not of these (regulate, de-fund, redistribute) policy approaches to climate and inequality. The main problem is that these are, obviously, highly partisan and deeply political actions on which people disagree rather strongly, at least outside of the bubbles in which international central bankers and NGO staff seem to operate.
Maybe climate change and inequality are the existential problems our economies must address. Perhaps green new deal controls, highly progressive taxation, universal basic incomes, and wealth taxes, rather than a carbon tax and a focus on opportunity—my favorites—are necessary means to fight them. But central banks and their supporting alphabet soup institutions should not appoint themselves to coerce financial institutions and governments to these causes, especially by such transparently dishonest means.
The concluding part of the essay points out that such blatant politicization will cost the institutions their independence, as well as their reputation for technocratic competence. But I think I said that well enough last time so I'll leave you here.
Update: International institutions
The real tragedy of this situation only struck me after the fact. I, and I suspect many of you, hold some conservative reverence for the postwar era of strong international institutions, and a rule-based international order, rather than the emerging era of bilateral deals among nations. Yet the evident rot at international institutions is one good reason countries are retreating from international institutions or ignoring them.
Update: New Zealand
Commenter Coker below points us to the Reserve Bank of New Zealand's climate initiative I read most of it as a pledge that many overpaid RBNZ employees will spend a lot of time churning out reports that nobody will read. But there is a clear statement of intent to implement ECB style policies, i.e. to use bank regulation to channel credit and subsidize 'green' (their scare quotes) investments:
"Engage with regulated entities to understand how climate related risks are being addressed within the sectors that we regulate. As part of this, the Bank will:
Engage with entities to explore their own internal climate risk strategies to evaluate the New Zealand financial system’s awareness and management of climate risks; and
Seek to identify opportunities to enhance disclosure of climate risks in New Zealand.
Monitor the development and operation of capital markets to identify any impediments to the efficient provision of finance for ‘green’ investments."