The right tools for the job? How effectively can central banks support the transition to net zero?

Utkarsh Somaiya, Caspar Siegert and Benjamin Kingsmore

Climate change creates material economic and financial risks which central banks need to understand to ensure monetary and financial stability. Their interest in climate change has therefore skyrocketed, with almost one third of central bank speeches in 2023 referencing climate change. Central banks are typically responsible for ensuring monetary and financial stability; these macroeconomic conditions are essential to support an orderly transition to net zero. But central banks are often urged to play a more active role and provide targeted support for the transition. Rather than discussing whether this is consistent with their legal mandates, we ask a more pragmatic question: do central banks have the right tools for this job? We argue that some commonly discussed tools may not be very effective.

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Same firms, different footprints: making sense of financed emissions

Lewis Holden

Over 95% of banks’ emissions are ‘financed emissions’. These are indirect emissions from households and businesses who banks lend to or invest in (banks’ asset exposures). Banks disclose these in line with regulations designed to help markets understand their exposure to climate-related risks and their impact on the climate. But emissions disclosures vary drastically between different banks with similar business models. Data quality and availability is cited as the key reason for this. In this post, I demonstrate that variations in financed emissions estimates are explained by the extent of banking activities and asset exposures rather than data quality and availability. For example, whether estimates capture a subset of loan exposures or wider banking activities such as bond underwriting.

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Adaptation is to mitigation what Robin is to Batman

Jenny Clark and Theresa Löber

The UK’s climate continues to change, getting wetter and warmer, with extremes becoming ever more pronounced. Even if we limit global warming to 1.5°C above pre-industrial levels, experts warn that we’ll see the number and severity of extreme weather events increase further. Without adaptation, we will see more property, infrastructure and agriculture damaged or destroyed, with devastating consequences to households, communities and businesses – as well as increasing risks to economic and financial stability. To date there has been relatively more focus on mitigation and the transition to net zero than on adaptation and addressing physical risk, across both government and the private sector. Adaptation is mitigation’s sidekick, we need them to consistently work together to achieve better outcomes. Much like Batman and Robin.

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Weathering the storm: the economic impact of floods and the role of adaptation

Rebecca Mari and Matteo Ficarra.

Floods are the most costly natural disaster in Europe. In the UK, they account for around GBP1.4 billion in annual losses. Yet, evidence on the macroeconomic implications is inconclusive. GDP often shows a puzzling delayed response, and prices can be pushed in opposite directions. Using a novel county level data set for England for the years 1998–2021, we estimate the impact of flooding on output and inflation at the sector level. Sectors react heterogeneously to floods, which explains well aggregate evidence. Prices respond in sectors related to both headline and core inflation, which has crucial implications for monetary policy. We further show that investing in flood defences mitigates the economic burden of floods by strongly reducing the risk of flooding.

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Staying afloat: the impact of flooding on UK firms

Benjamin Crampton, Rupert-Hu Gilman and Rebecca Mari.

With climate change set to increase the frequency and intensity of flooding in the UK, it is important to deepen our understanding of the potential microeconomic impacts that may propagate into the macroeconomy. We integrate firm-level corporate records, with Ordnance Survey business-premise address information and publicly available flood maps to investigate two questions. First, what characteristics of firms are associated to the historical exposure and current risk of flooding; and second, what is the impact of flood events on corporate outcomes. We find significant sectoral, spatial and structural heterogeneity among firms in their risk and exposure to flooding. Larger firms are more likely to locate in flood zones, while small and medium-sized enterprises (SMEs) and natural-resource-related industries have historically been impacted most heavily.

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The heterogenous effects of carbon pricing: macro and micro evidence

Ambrogio Cesa-Bianchi, Alex Haberis, Federico Di Pace and Brendan Berthold

To achieve the Paris Agreement objectives, governments around the world are introducing a range of climate change mitigation policies. Cap-and-trade schemes, such as the EU Emissions Trading System (EU ETS), which set limits on the emissions of greenhouse gases and allow their price to be determined by market forces, are an important part of the policy mix. In this post, we discuss the findings of our recent research into the impact of changes in carbon prices in the EU ETS on inflation and output, focusing on how the emissions intensity of output – the quantity of CO_² emissions per unit of GDP – affects the response. Understanding these economic impacts is important for the Bank’s core objectives for monetary and financial stability.

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Climate and monetary policy series

Boromeus Wanengkirtyo, Francesca Diluiso, Rebecca Mari, Jenny Chan, Ambrogio Cesa-Bianchi and Alex Haberis.

Climate change is becoming increasingly important for monetary policy as the world transitions into greener economies and climate change’s physical impacts become more prominent. This is complementary, but distinct to, examining how climate change affects financial stability risks (Carney (2015)). This series of posts highlights how climate change can affect key economic variables such as output and inflation, and thereby the conduct of monetary policy. Climate change and climate policies represent another set of economic shocks and structural changes to monitor, so that monetary policy can meet its objectives.

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Some implications of climate policy for monetary policy

Francesca Diluiso, Boromeus Wanengkirtyo and Jenny Chan.

This post examines key aspects of climate mitigation policies that could matter for monetary policy, using insights from structural climate macroeconomic models (Environmental Dynamic Stochastic General Equilibrium). Three main findings emerge: first, mitigation policies – like carbon pricing – can be a direct source of shocks, creating potential trade-offs for monetary policy (Carney (2017)). Second, the degree to which these policies are anticipated affects their macroeconomic impacts. Third, different climate policies may alter the transmission of conventional business-cycle shocks, therefore affecting the calibration of optimal monetary policy. We focus on the 3–5 year horizon, abstracting from longer-run considerations and changing trends such as interactions with the zero lower bound, the natural interest rate, or transitional effects on productivity and output.

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Capitalising climate risks: what are we weighting for?

David Swallow and Chris Faint

Policymakers have been investing heavily, to an accelerated timeline, to better understand the financial risks from climate change and to ensure that the financial system is resilient to those risks. Against that background, some commentators have observed that the most carbon-intensive sectors may be subject to the greatest increase in transition risk. They argue that these risks are not currently included within risk weights in the banking prudential framework and that regulators should adjust the framework to include them. Conceptually, this argument sounds credible – so how might UK regulators approach whether to adjust the risk-weighted asset (RWA) framework to include potential increases in risks? This post updates on some of the latest thinking to help answer this question.

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Climate and capital: some outstanding issues

Marco Bardoscia, Benjamin Guin and Misa Tanaka

There is a lively debate about whether and how capital regulations for banks and insurers should be adjusted in response to climate change. The Bank of England will host a conference later this year to discuss the points in favour of and against adjustments to the regulatory capital framework to take account of climate-related financial risks. The call for papers asks for research on appropriate capital tools to address these risks, eg whether risks point to microprudential tools which are firm specific or rather macroprudential system-wide ones. Moreover, it asks for research on an appropriate time horizon over which the risks should be considered and how scenarios and forward-looking data should be used. This post will review the existing literature and identify some key gaps.

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