The Jackson Hole symposium is the perfect opportunity for central banks to fully account for carbon emissions in their monetary policy toolkits, says Frank Van Gansbeke of Beyond Bretton Woods.
Central banks are, in finance parlance, sleeping beauties: admired for their financial firepower and feared for the impact they exert on global financial markets. Yet they have lost some of their lustre recently due to the length of time it took to contain inflation, as well as their conspicuous silence on the ways that climate change threatens financial stability.
At the upcoming Jackson Hole meeting, the Kansas Federal Reserve will host central bankers and economists on the theme of “reassessing the effectiveness and transmission of monetary policy”, and the meeting could not be timelier.
Johan Rockström, the leading climate impact expert, draws attention to the fact that the planet’s temperatures are hitting the warmest on record within the last 100,000 years. One example: Phoenix in Arizona experienced 25 consecutive days in July with record temperatures of at least 110ºF (43ºC). These trends represent risks that impact supply chains, harvests, productivity, physical damages and ultimately lives. These risks are currently left out of monetary policy scope, while the supply side is totally impervious to interest rate policy.
Brian Deese, one of the architects of the Inflation Reduction Act, asks whether ”emerging technologies – nuclear, geothermal, hydrogen, carbon capture – scale fast enough?” These promising technologies are valuation hampered by central banks’ high interest rates and the lack of recognition of technology’s ability to reduce financial systemic risk and improve quality of life.
Despite central bank claims of independence, policy execution still favours incumbent industries, particularly oil and gas, and burdens society at large with high interest rates.
Central banks still fail to capture system-threatening non-monetary aggregates in their monetary policy assessment, such as levels of atmospheric CO2, the threat of wet bulb temperatures (a heat stress condition where life is no longer sustainable) and the extensive breach of planetary boundaries. Despite central bank claims of independence, policy execution still favours incumbent industries, particularly oil and gas, and burdens society at large with high interest rates. Central bank abstraction for ensuring a smooth ecological transition leads to monetary policy decisions that fail to hit the mark and result in unmanaged risks in the face of supply-side driven climateflation, fossilflation and greedflation.
Between March 2022 and January 2024, the Fed hiked rates 11 times, to bring inflation down from 9.1% in 2022 to 3% by June 2024, still 1% shy of the Fed’s inflation target. In summary, the market is saddled with a 23-year peak in central bank rates, at a time when low rates are needed to support the slowing of accelerating climate change through investment in the likes of heat pumps, grid replacement and renewal, and battery storage.
Why are markets unaffected by climate change?
Today, global equity and bond markets are still data- and price-agnostic with regard to the risks linked to climate change. The recent equity market correction was, for example, amplified in part by the Bank of Japan’s 1% rate increase on 31 July, but not in the least affected by the scientific evidence of Antarctica’s Thwaites (or “Doomsday”) glacier melting at record speed or the glacial outburst flood near Juneau in Alaska, setting a record for a second year in a row on 6 August.
Why are future losses emanating from climate change’s physical risk not discounted in today’s prices?
Equity markets today still use an outdated capital asset pricing model (CAPM.) This model favours individual stock price volatility in relation to the market volatility as price constituent. Yet it fails to translate the promising patents of cooling alternative energy technologies in a lower cost of capital. In reverse, the same model is incapable of increasing cost of capital due to a company’s core contribution to greenhouse gases and/or financial systemic risk.
As an example: the mitigation cost for solar energy, with a levelised cost of less than 5 cents per kWh has never been so low, yet it contributes only 5% to the global electricity supply. From a peak in January 2023, the S&P Global Clean Energy Index has lost 38% in value, while the S&P 500 oil and gas exploration and production index is up by more than 12% over a six-month period. This clean energy price decline is in reverse correlation to the need to identify opportunities for cooling the earth.
Why are future losses emanating from climate change’s physical risk not discounted in today’s prices?
A novel monetary policy could consist of a bifurcated interest rate monetary policy (think lower interest rates for green technology or grid replacement through long-term refinancing operations). Or open market operations on the back of central bank eligible collateral criteria attuned towards the ecological transformation at a lower refinancing rate. Or a global framework for supporting a transparent 24/7/365 carbon price shaped by global cap and trade programmes and inspired by the existing ICE Carbon futures contract traded on the New York Stock Exchange.
So until we have Wall Street using a carbon-adjusted CAPM firm valuation alternative incorporating the societal relevance of the levelised cost of energy, along with central banks designing and deploying an innovative monetary policy toolkit, then emerging green technologies will keep on gathering dust.
It would be a historical parody that a too-narrow embrace of orthodox monetary policies in the face of proven and affordable solutions today would trigger unorthodox policies in the future at a scale, cost and levels of mayhem hitherto unseen, due to the obfuscation of unpriced-for but plain-to-see risks now.
Featured photo: Jackson Hole, Wyoming
