Home / Opinion / Columns /  Let central banks stay focused on their goals
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Extreme weather events around the world have left little space for doubt over climate change as a threat. Sadly, the world is failing to combat it. But should central banks join the fight? Should monetary policy be assigned a role? Weighing in on this debate last week, former Reserve Bank of India (RBI) governor Urjit Patel laid out a cogent argument in favour of that proposition. Broad economic stability is a key goal for any central bank, and an inflation-targeter must primarily foster the expansion of an economy without price levels going out of control, which is typically done via its influence on money supply. Just as recklessly fast growth tends to stoke inflation and raise other risks, in Patel’s view, the same is true of its effect on carbon emissions, with the covid disruption having made pollution’s link with growth abundantly clear, and may thus call for similar moderation. To the extent that the ravages of climate change endanger output, this may become important for economic sustainability in itself. Before the financial crisis of 2008, the US central bank’s effort to close its output gap (from estimated potential) had a sharp inflation focus that let financial risks pile up and led to a great recession. A few central banks began to rework their output-gap models to cover those risks too. Patel would now have us expand this rationale to climate risks by adding these to our calculus of a growth-pace that can be sustained without overheating on multiple fronts, the planet included—literally.

Advances in climate studies probably make Patel’s proposal technically feasible. Upheavals caused by global warming are major worries, so it’s also likely to hold appeal around the world. We would need a worldwide switchover for it to serve as an equitable economic restraint, though, and a consensus will not be easy to achieve. Consider the cogency of the counter-argument. Former Bank of England governor Mervyn King recently articulated why central banks must not be burdened with a climate agenda. In his view, it is beyond their expertise, and it is hard enough for them to get their basics right, such as keeping the internal value of their currencies stable. His specific objection was to central banks being asked to tilt asset purchases towards green bonds. Raghuram Rajan, Patel’s predecessor as RBI governor, has also opposed the adoption of plainly fiscal objectives like spurring eco-friendly investments by monetary authorities. He spoke against central banks with sufficiently wide mandates running policies best run by governments.

On balance, we must not rush into mixed mandates in response to our current climate emergency. As it is, central banks have a complex job, with wind-backs of extra-easy money policies a big challenge for most. Errors can prove exorbitant. The added complexity of green-growth calculations could result in poorer outcomes overall. It would shroud policy rates of interest in a data fog that will make it harder for analysts to subject central banks to scrutiny. Strictly financial targets allow for ease of performance and evaluation, clarity on both of which is critical. Climate settings are a political matter, and, as King cautioned, taking up such a cause would expose central banks to the risk of lost autonomy—vital for long-range stability. This is not to downplay our climate crisis. To tackle it, ideas like a carbon market and Rajan’s call for a global incentive framework should be put to work. Let central bankers do what we need them for.

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