What do interest rates and bank regulations have to do with social justice and environmental decay? Potentially, quite a bit.
Central banks can and should pay close attention to key issues like income inequality and climate change even if these fall outside their traditional mandates, argues Patrick Honohan, former governor of the Central Bank of Ireland, in a recent working paper from the Peterson Institute for International Economics.
“Should central banks resist the calls to take more account of ethical distributional and environmental concerns in the design and implementation of the wider set of monetary policy tools they have been using in the past decade?” asks Honohan.
“Many central bankers will baulk at the idea, fearing a damaging loss of independence and a dangerous distraction from their core competencies. These are clearly valid and important concerns.”
Yet he argues that simply ignoring such massively important issues makes the central bank more, not less of a political target because it will increasingly appear out of touch.
“The secondary mandates, whether explicit or implicit, of central banks, arguably warrant attention to large systemic issues like climate change and inequality, to the extent that these can be significantly influenced without detracting from the primary goals of monetary policy,” Honohan adds.
“Central banks have been behind the curve of society’s response to these issues and could make a worthwhile contribution in a number of respects. Indeed, while they may fear encroachment on their independence, such a threat may be greater for central banks that neglect reasonable public expectations in these dimensions.”
Honohan deftly pushes back against the notion, often floated in financial markets, that looser monetary policy has goosed inequality.
“The sharp and sustained rise in the market price of long-term bonds has triggered complaints from egalitarians concerned that low-income households do not have sizable holdings of such bonds,” he writes.
Yet higher bond prices resulting from central bank asset purchases such as were pursued during the Great Recession are only the first and most immediate consequence of monetary easing, Honohan adds.
“The purchases affect yields throughout the financial system, and engender behavioural responses that increase aggregate demand and economic activity,” he argues.
“Thus, although the direct impact on asset prices is generally understood to widen wealth inequality, the same asset purchases can be needed to accelerate the economy’s return to high employment, which has a narrowing effect on vertical income inequality (and on the distribution of human capital.”
Honohan is more receptive to another critique of central banks—that their activities may have a negative environmental impact by boosting the revenues of firms that have a large carbon footprint, particularly in Europe and Britain, where central banks have bought not just government bonds but also corporate debt.
“Central banks that have bought private securities as part of their monetary policy are behind the curve in this dimension and, in their attempt to be market neutral, risk being seen as opposed to a growing consensus for the need for private and public actions to address climate change,” Honohan says.
Central bank officials have started paying increasing attention to the issue of climate change in recent years.
Just last month, Federal Reserve Governor Lael Brainard gave a speech entitled “Why Climate Change Matters for Monetary Policy and Financial Stability.” In it, she said “similar to other significant risks, such as cyberattacks, we want our financial system to be resilient to the effects of climate change.”
All credits to the original source by Pedro Nicolaci da Costa