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Why the Federal Reserve Should Address Climate Change’s $150 Billion Economic Impact Similar to Its Response to Other National Crises It Has Assisted in Combating

Climate-related disasters now incur an annual cost of $150 billion in the United States, with escalating economic repercussions. The real estate sector is grappling with disruptions as home insurance premiums surge due to heightened wildfire and flood risks linked to climate warming. Agricultural disturbances contribute to rising food prices, while healthcare expenses escalate amid the toll of increased heat. The adverse impacts disproportionately affect marginalized and vulnerable communities, exacerbating their financial challenges. Despite the mounting economic turbulence, the Federal Reserve, tasked with ensuring economic stability, currently excludes the instability induced by climate change from its monetary policy considerations. Earlier this year, Federal Reserve Chair Jerome Powell explicitly stated, “We are not, and we will not become, a climate policymaker.”

Powell argues that, to safeguard the Federal Reserve’s independence from political influences and cycles, its tools should be wielded narrowly, concentrating on its primary mission of ensuring economic stability. This encompasses maintaining price stability by curbing inflation and optimizing employment. According to Powell, the Federal Reserve should refrain from delving into social and environmental issues that lack a direct and close connection to its statutory objectives.

Ensuring stability becomes increasingly challenging for central banks unless they incorporate climate instability into their monetary policies. As experts in climate justice and central banking, we recently published a paper examining the monetary policy tools available to central banks worldwide that could contribute to slowing climate change and mitigating climate vulnerabilities. Given the inadequacy of U.S. policies and actions, as highlighted by the new U.S. National Climate Assessment and other research, in addressing climate instability and managing its growing economic costs, we propose a reconsideration of the role of central banks in responding to the climate crisis.

One potential measure for central banks is to establish lower interest rates specifically for the development of renewable energy, a strategy previously employed by the Bank of Japan. The Federal Reserve’s robust increases in interest rates, triggered by mounting inflation, have impeded the shift toward a more sustainable society. This support for fossil fuels and the consequent escalation of costs for investments in renewable energy infrastructure, including setbacks in offshore wind power projects, underscores the detrimental impact of higher interest rates.

Introducing varied interest rates could involve establishing a specialized lending facility wherein commercial banks could access funds from the central bank at preferential rates if utilized for renewable energy initiatives or other climate-friendly investments. The feasibility of this approach for the Federal Reserve hinges on the interpretation of its existing mandate. While the U.S. Federal Reserve has not implemented such measures previously, China’s central bank and the Bank of Japan have utilized similar tools to incentivize renewable energy, offering preferential interest rates and zero-interest loans for green investments, respectively.

Despite the Federal Reserve’s commitment to avoid favoring specific industries, its monetary policies have inadvertently benefited established sectors, including fossil fuels. Notably, during the COVID-19 pandemic, the Fed provided unconditional support to the financial sector, maintaining credit availability to mitigate economic damage. However, its substantial corporate bond purchases resulted in subsidies to the fossil fuel industry.

Our analysis proposes two avenues for immediate climate management: firstly, the Fed could reassess its current statutory obligations, recognizing climate action as a vital aspect of its role in preserving economic stability within its existing mandate, akin to the European Central Bank’s approach. Alternatively, Congress could modify the Fed’s mandate to explicitly include “green” transformation objectives, resembling the U.K.’s mandate for the Bank of England. Either option would empower the Fed to address climate change and assist in financing climate mitigation and adaptation endeavors for the government, businesses, banks, households, and communities.

The Federal Reserve could deter banks and investors from supporting assets that pose harm to the economy by implementing measures like establishing collateral requirements, diminishing the appeal of carbon-intensive assets for banks. This approach aligns with recent moves by the European Central Bank, which disclosed plans to shift corporate bond purchases towards environmentally friendly assets.

Although the Fed has initiated actions to prompt major financial institutions to assess climate-related risks in their portfolios, the effectiveness of this risk management strategy in altering lending behaviors remains uncertain. To enhance climate-focused interventions, the Fed and other central banks could mandate energy transition planning, prioritizing economic stability. Drawing inspiration from the European Union’s sustainable finance framework, the aim is to discourage investments that do not align with the energy transition objectives outlined in the European Green Deal.

Throughout its extensive history, the Federal Reserve has utilized innovative tools to provide financial support during significant crises, such as wars and recessions, by extending direct lines of credit or directly acquiring Treasury bonds. Amid the escalating costs of the climate crisis, we argue that the Fed should approach climate change with the same sense of urgency and significance it has historically applied to major crises.

In our examination of the tools at the disposal of central banks, we adopted a climate justice perspective that extends beyond mere reductions in greenhouse gas emissions to encompass considerations of social justice and economic equity. Rather than solely concentrating on supporting corporate interests and the financial sector for short-term market stabilization, we advocate for central banks to prioritize long-term stability by directing investments toward vulnerable communities and individuals.

Some central banks, such as the Bank of England and the European Central Bank, have already begun implementing pro-climate measures. However, at the Federal Reserve, Powell appears to be more concerned about potential political backlash than the economic repercussions highlighted in the most recent climate assessment.

We firmly assert that it is high time for the Federal Reserve to recognize climate destabilization as a significant economic crisis and to leverage a broader array of tools within the central bank’s toolkit to address this pressing issue.

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