The role of monetary policy in green transition

To be ‘green’ or not, Part 2: The role of monetary policy in changing green

Climate change is increasingly affecting our society and economy. A rapid transition to a low-carbon economy is needed to adapt to this and reduce its consequences. The primary responsibility for this change rests with the government. They are legitimate and have a wide spectrum of policy levers at their disposal, such as pricing the necessary carbon emissions, defining a regulatory framework for reducing emissions, and taking the necessary sustainable investment initiatives. The 2015 Paris Agreement embodied a global policy response.

Nevertheless, government action alone is not enough to address the complexities and scale of the transformation needed to achieve climate change, and there is a growing consensus that a comprehensive policy package would be more effective in tackling multiple market failures at the root of the climate. CHALLENGE Such a comprehensive policy package requires a mix of financial, regulatory and structural measures as detailed in Pisu et al. (2022), as well as monetary policy instruments and monetary policy measures which we further review below (ECB 2021, Weder di Mauro 2021).

How can the central bank respond to climate change?

A key factor in shaping the central bank’s response to the climate challenge is the mandate assigned to them. When Dikau and Volz (2021) analyzed 135 central bank legislation orders, they found that only 12% had a mandate that clearly indicated sustainable growth or development. However, 40% is binding to support the government’s policy priorities, which in most cases include sustainability goals.

For central banks with a clear ‘green mandate’, the issue is clear in terms of action. But even in the absence of such instructions, taking any action is not an effective option. There are a number of steps that central banks may consider and both may consider in supporting climate policies and utilizing green financing, provided that their policy framework remains resilient to emerging climate risks and contributes to the decarbonization goals set by the relevant political authorities. .

The literature on policy options available to central banks to respond to climate change is rapidly evolving but still fragmented. Boneva et al. (2021, 2022), we propose the classification of policy measures into three categories from defensive to active depending on their goals (Figure 1).

Figure 1 Possible steps by the central bank to respond to climate change

The first section covers measures to protect the balance sheets of central banks and to protect their ability to issue price stability orders against the materialization of climate risk. Central banks have a responsibility to protect the integrity of their balance sheets and to operate prudently as a means of ensuring that they are able to consistently order their price stability over time. Policies can be considered to reduce the weight of assets at risk of becoming ‘immobile’ in the central bank portfolio, if there is evidence that these risks are not properly understood and valued by the financial market and that such assets can be objectively identified.1 Measures aimed at enhancing the central bank’s analytical toolkit for measuring the impact of climate change on the economy also fall under this category (NGFS 2021). The monetary policy framework should also adapt to climate-related risks and shocks (ECB 2021).

The second section includes measures aimed at raising awareness about climate risks that can also help promote green financing and sustainable growth, but the central bank does not have to actively use its balance sheet. They cover a wide range of activities ranging from communicating with the public and financial community about climate risk to publishing the carbon footprint of the central bank’s own balance sheet.2 These measures could benefit from a classification scheme to rank sectors and activities and sort out pollution from green investment – such as the EU classification – to promote more efficient market value of climate risk. Many central banks and supervisors are actively contributing to the work of the Network for Greening the Financial System (NGFS).

The third section includes measures aimed at actively mitigating climate change, including the active use of central bank balance sheets, and promoting transformation into a low-carbon economy. Depending on the central bank’s legal mandate and operational structure, active support for the transition to a low-carbon economy can be achieved by changing the value of central bank facilities or changing eligibility criteria (Figure 2). Given the size of the current central bank balance sheets, the effect of greening the central bank’s portfolios may be substantial in some cases. Furthermore, there could be significant signaling effects for market participants.

Figure 2 Greening of central bank portfolios through pricing or eligibility criteria

Non-monetary policy portfolios, such as staff pension funds and own funds, form an appropriate starting point for actively greening central bank portfolios. Many central banks have already taken steps in this regard.

Recently, some central banks have started allocating a portion of their overseas reserves to green securities. This could create more trade-offs for reserve managers because of the potentially low liquidity of green bonds and their relatively small market share. However, in an exemplary practice, BIS (2019) found that holding both green and conventional bonds could help central banks improve risk-adjusted returns by cutting the benefits of diversification.

The policy portfolio of all major central banks has grown in recent years due to the purchase of long-term assets to achieve price stability. Many central banks make these purchases in proportion to their outstanding market share, a practice that gives rise to a ‘carbon bias’ because carbon-intensive companies are generally capital-intensive and therefore have a greater weight in the corporate bond market than their low-carbon ones. – Intensive colleague. Given this ‘market failure of climate change’, the traditional criteria for purchasing central bank assets based on market neutrality may not be appropriate. Schoenmaker (2019) proposes a tilting approach that drives central bank asset holdings toward low-carbon companies. Similarly, banks also reveal lending carbon bias, as discussed, in Bayenne et al. (2021). To address this, central banks may require access to specific financing facilities based on how much individual adversaries contribute to climate change mitigation and adaptation through their lending, or how much they plan to do in the future.3

In addition, central banks may green their implementation framework by reviewing pricing or eligibility criteria for securities to be adopted as part of their lending activities. This can be done by introducing climate-related disclosure requirements for the use of private sector resources as collateral in central bank activities. Alternatively, central banks may pursue negative or positive screening for certain types of financial assets when used as collateral, if possible.

What constraints, trade-offs and challenges will the central bank face?

Central banks playing an active role in raising awareness about climate risks may face various limitations and may face criticism. Communicating publicly about the urge to green the financial system can be seen as an attempt to gain more work and power. In addition, there is a risk of raising too much expectations about what central banks can effectively achieve.

Another set of concerns is about the adjustment of central bank policies, usually aimed at smoothing business cycle fluctuations, to address the structural changes needed to cope with climate change: for example, if the return on inflation reduces asset purchases Cannot be used to support climate-related purposes. Nevertheless, the central bank may aim to set the desired monetary policy position in a ‘green way’. Furthermore, by reducing the conversion costs of investing firms to reduce emissions, monetary policy could pave the way for carbon neutrality, creating some lasting effects.

Finally, greening monetary policy can distort financial markets, especially due to the current lack of green resources. The transition to monetary policy may be hampered if, for example, some institutions are excluded from accessing central bank facilities. Moreover, in the absence of a clear classification of what is ‘green’ and what contaminates investments, and in the absence of recognized market values ​​and without enforceable guidelines, central banks lack a purposeful definition and perhaps a legal basis for basing their green policies. Given these limitations and trade-offs, central banks need to strike a balance between the costs and benefits of any green move.

Author’s Note: The opinions expressed herein do not necessarily reflect those of the author and the European Central Bank (ECB) or the Eurosystem.


BIS (2019), “Green Bonds: Reserve Management Perspectives”, Quarterly reviewSeptember.

Beyene, W, M Delis, K de Greiff and S Ongena (2021), “To big to strand? Bond vs. Bank Financing Transforms into a Low Carbon Economy ”,, 04 December.

Bolton, P, S Reichelstein, M Kacperczyk, C Leuz, G Ormazabal and D Schoenmaker (2021), “Mandatory Corporate Carbon Disclosure and the Path to Net Zero”,, 04 October.

Boneva, L, G Ferrucci and FP Mongelli (2021), “To Be ‘Green’ or Not: How Monetary Policy Can Respond to Climate Change?”, Action Paper Series, No. 285, ECB.

Boneva, L. G. Ferruchi and FP Mangeli (2022), “Climate Change and the Central Bank: What Role for Monetary Policy?”, Climate Policy.

ECB (2021), “Climate Change and Monetary Policy in the Eurozone”, Auction Paper, No. 271, ECB.

Dikau, S and U Volz (2021), “Central Bank Mandate, Sustainable Purpose and Promotion of Green Financing”, Environmental economy 184

Klusak, P, M Agarwala, M Burke, M Kraemer and K Mohaddes (2021), “Rising Temperatures, Melting Rating”,, 25 March.

NGFS (2021), “Adapting Central Bank Activities to a Heated World: Reviewing Some Alternatives”, March.

Pisu, M, FM D’Arcangelo, I Levin and A Johansson (2022), “A Framework to Decarbonize the Economy”,, 14 February.

Schoenmaker, D (2019), “Greening Monetary Policy”,, 17 April.

Weder di Mauro, B (ed.) (2021), Fighting Climate Change: A CEPR Collection, CEPR Press.


1 Klusak et al. (2021) Investigate whether the value of financial assets accurately reflects climate risk.

2 Bolton et al. (2021) documentes the benefits of mandatory corporate carbon emissions to reduce emissions.

3 For example, access to some of the central bank benefits discussed in NGFS (2021) may require a density limit for opponents or a minimum share of low-polluting assets for high-polluting assets.

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