Should central banks have a green mandate?

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In his March budget, British Chancellor of the Exchequer Rishi Sunak broadened the Bank of England’s mandate to include support for the government’s goal of achieving net zero greenhouse gas emissions. ‘by 2050. But in a June 8 letter to the Financial Times, Mervyn King, a former BOE governor, sharply criticized the move. King warned that “an expansion of central bank mandates in policy areas such as climate change […] threaten[s] de facto weakening the independence of the central bank, causing a slow response to signs of rising inflation. ” So what’s up?

A little history can help. By the 1980s, there was a consensus among policymakers that the main macroeconomic problem was inflation. Governments’ “Keynesian” efforts to push unemployment below its “natural rate” have made them unreliable gatekeepers of the value of money.

Governments have therefore contracted out inflation control to “non-political” central bankers. In 1997, Britain’s new Labor government, well aware of the party’s reputation for extravagant spending, gave the BOE a mandate to achieve an inflation target of 2.5% (later reduced to 2 %). The power to set the official interest rate (Bank Rate) has been transferred from the Treasury to the BOE’s Monetary Policy Committee.

The newly empowered BOE was expected to raise its interest rate when inflation trended above 2%, and lower when inflation (or the price level) fell. In addition, the medium-term nature of the inflation target has given the BOE some leeway to adjust its interest rate policy to reflect economic activity. This monetary regime, adopted by most of the central banks of rich countries, has been credited with maintaining price stability during the so-called “great moderation” which lasted until 2008. But low commodity prices, conservative fiscal policy and China’s integration into the world economy were almost certainly more important factors than the technocratic calibrations of independent central bankers.

During the 2008 global financial crisis, however, central banks went beyond their traditional role of lender of last resort and bailed out failed commercial banks deemed “too big to fail”. As the banking crisis turned into a severe economic downturn and official interest rates fell to near zero, fulfilling the inflation mandate was seen as requiring additional monetary policy tools. Get into quantitative easing (QE), or “unconventional monetary policy,” which meant flooding the economy with money to offset the effects of the contraction in business.

The central banks charged with controlling inflation were therefore now using monetary policy to avoid economic collapse, for which they had no mandate. Amid the confusion that ensued as to the nature of their role, monetary policy makers claimed that their massive purchases of public debt, amounting to hundreds of billions of dollars, euros and pounds sterling between 2009 and 2016, aimed to “increase the inflation rate to achieve.” “But everyone knew inflation was the last thing they thought about as their economies plummeted.

If central banks had openly proclaimed their role as lifesavers of last resort, most people would have said it was the government’s responsibility, and with good reason. As John Maynard Keynes pointed out 80 years earlier, it is the spending, not the printing, of central bank money that is critical to economic activity.

Central banks have never satisfactorily answered the question of how their massive monetary injections were supposed to increase real economic activity, or raise prices for that matter. As economies continued to stagnate, the best they could do was say things would have been worse without QE.

Then, as the recovery from the 2008-09 financial shock was far from over, the Covid-19 pandemic struck. This time around, it was governments that (rightly so) began to spend on a large scale to maintain the purchasing power of corporations in the face of mass lockdowns. Central banks, ostensibly pursuing their inflation targets, were now financing the scale of public spending chosen by governments, without anyone bothering to change their mandate. Some intrepid minds have asked how the financing of an ever-growing public deficit could be compatible with the achievement of an inflation target of 2%. But asking this question was considered bad form, as it “undermined the credibility” of the central bank’s anti-inflationary mandate.

Sunak’s new mandate on climate change, which at least has the merit of being transparent, therefore comes at a time when the waters of monetary policy are already blurred and the meaning of central bank independence is blurred. Establishing greater clarity on these issues was one of the main aims of the recent UK House of Lords Economic Affairs Committee inquiry into monetary policy.

The committee’s report, Quantitative Easing: A Dangerous Addiction ?, traces in detail the gradual deterioration in the coherence of the BOE’s mandate. It recognizes that the prevention of catastrophic climate change should be a central concern of public policies. The problem is simply to what extent the central bank could be drawn into political affairs without undermining the credibility conferred by its independence from politics. The committee’s report cautiously concludes that due to the Chancellor’s expansion of the BOE’s mandate, “the Bank risks being forced into the political arena.”

But the important question is not to what extent the BOE’s expanded mandate undermines its anti-inflationary credentials, but rather to what extent it blurs the responsibilities of the government and the central bank for the conduct of economic policy. The current regime assumes that central bankers should control the quantity of money, while the allocation of money (or capital) by the budget would remain in the hands of democratically elected governments.

But involving central banks in allocating money to companies or sectors on the basis of their “greening” potential – by buying the debt of hydropower companies but not that of oil companies, for example – forces them to take debt. policy decisions for which the government should be held accountable through the tax system. The British government’s desire to use the quantitative easing tool to outsource the allocation of capital to a non-responsible body is therefore a new step in its abdication of the responsibility to guarantee a healthy and sustainable economy.


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