Green Monetary Policies: the Missing Link Between Finance and Sustainability?

The UN COP21 climate conference held in Paris in December 2015 reached the remarkable agreement to limit global temperature increase below 2 degrees C above pre-industrial levels. In order to meet this target, a carbon budget of about 1 000 gtCO should be respected (IPCC, 2013). This implies that fossil reserves owned by companies would become unburnable (Leaton, 2012; Kartha et al., 2016). These trends suggest that, from one hand, there is a growing risk to holding equity in fossil fuel companies and, from the other, that there is momentum for investing in the low carbon economy. Indeed, costs of renewable energy production are falling, and returns on renewable energy investments (OECD/IEA, 2015) increasing. Then, expansionary monetary policies, such as the Quantitative Easing (QE) schemes by the European Central Bank (ECB) and the Bank of England (BoE) contribute to keep interest rates low, while Long Term Refinancing Operations (LTRO) effectively set a conditionality for investments.

Yet, market failures delays capital mobilization in green new projects at the pace and amount needed. A high-risk perception towards green investments reflects in a higher cost of capital for green project and, at the same time, in risk underpricing for investments in climate relevant sectors, i.e., sectors (and assets) that rely on fossil fuels extraction and use (Battiston et al., 2016).

In this seminar we will explore the role that Central Banks’ monetary policies could play to support the transition to a low carbon economy. In particular, we analyse the role of green sovereign bonds as an implementing tool of a green QE, discussing opportunities and challenges. Finally, by applying the Eirin model (Monasterolo and Raberto, 2016) we show that supporting new green investments through green monetary policies implemented via green sovereign bonds could deliver better results in terms of macro-economic performance and credit market stability, with less distributive effects than with the introduction of green fiscal policies.