Tuesday 26 October 2021

Core business for a central bank

Inflation hit 2.2% in the most recent quarter. Not the annual rate - the rate for the quarter.

Arguably, Reserve Banks shouldn't be making statements about inflation outside of the scheduled monetary policy schedule. 

But it seemed a bit odd that the Bank put out a release on establishing the Māori Bankers Rōpū to coincide with the release of the inflation statistics. 

They came out within minutes of each other, as though the Bank were saying "Yes, the CPI numbers are out today, but here's what we're really interested in." 

New Zealand has an Emissions Trading Scheme that caps net emissions.

The ETS is nowhere mentioned in the report. 

The Executive Summary tells us that "Climate Change is part of our core business". 

It simultaneously tells us that the Reserve Bank has forgotten what its core business is. 

Its core business is keeping inflation between 1 and 3 percent over the medium term while maximising sustainable employment outcomes (which really means just maintaining stable inflation between 1 and 3 percent because the rest is out of the Bank's hands). 

If climate change is core Bank business, because it affects financial stability, is there *anything* that is not part of the Reserve Bank's remit? Housing policy would be the obvious starting point, but why stop there? Freshwater regulation may have financial stability implications. 

The question is whether the ECB, other central banks, and international institutions such as the IMF, BIS, and OECD should appoint themselves to take on climate policy, or other important social, environmental or political causes, without a clear mandate to do so from politically accountable leaders.

Moreover, the ECB and others are not just embarking on climate policy in general. They are embarking on the enforcement of one particular set of climate policies — policies to force banks and private companies to de-fund fossil fuel industries, even while alternatives are not available at scale, and to provide subsidized funding to an ill-defined set of “green” projects.

To be concrete, I quote from Executive Board Member Isabel Schnabel’s recent speech. I don’t mean to pick on her, but she expresses the climate agenda very well, and her speech bears the ECB imprimatur. She recommends
First, as prudential supervisor, we have an obligation to protect the safety and soundness of the banking sector. This includes making sure that banks properly assess the risks from carbon-intensive exposures…
Let me speak out loud the unclothed emperor fact: Climate change does not pose any financial risk, at the 1, 5 or even 10 year horizon at which one can conceivably assess the risk to bank assets.

“Risk” means variance, unforeseen events. We know exactly where the climate is going in the next 5 to 10 years. Hurricanes and floods, though influenced by climate change, are well modeled for the next 5 to 10 years. Advanced economies and financial systems are remarkably impervious to weather. Relative market demand for fossil vs. alternative energy is as easy or hard to forecast as anything else in the economy. Exxon bonds are factually safer, financially, than Tesla bonds, and easier to value. The main risk to fossil fuel companies is that regulators will destroy them, as the ECB proposes to do, a risk regulators themselves control. And political risk is a standard part of bond valuation.

That banks are risky because of exposure to carbon-emitting companies, that carbon-emitting company debt is financially risky because of unexpected changes in climate, in ways that conventional risk measures do not capture, that banks need to be regulated away from that exposure because of risk to the financial system is nonsense. (And if it were not nonsense, >regulating bank liabilities away from short term debt and towards more equity would be a more effective solution to the financial problem.)

...Now you may say, “climate is a crisis. Central banks must pitch in and help the cause. They should just tell banks to stop lending to the evil fossil fuel companies, and print money and hand it out to worthy green projects.”

But central banks are not allowed to do this, and for very good reasons. A central bank in a democracy is not an all-purpose do-good agency, with authority to subsidize what it decides to be worthy, de-fund what it dislikes, and to force banks and companies to do the same. A central bank, whose leaders do not regularly face voters, lives by an iron contract: freedom and independence so long as it stays within its limited and mandated powers.

The ECB in particular lives by a particularly delineated and limited mandate. For very good reasons the ECB was not set up to decide what industries or regions need subsidizing and which should be scaled back, accordingly to direct bank investment across Europe, to set the price of bonds, and and to print money to subsidize direct lending. These are intensely political acts. In a democracy only elected representatives can take or commission such intensely political activities. If I take out the words “green,” you, EU member states, and EU voters would properly react with shock and outrage at this proposal.

That’s why this movement goes through the convolutions of pretending that defunding fossil fuels and subsidizing green projects — however desirable — has something to do with systemic risk, which it patently does not.

That’s why one must pretend to diagnose “market failures” to justify buying bonds at too high prices. By what objective measure are green bonds “mispriced” and markets “failing?” Why only green bonds? The ECB does not scan all asset markets for “mispriced” securities to buy and sell after determining the “right” prices.
But the Bank makes it even more obvious that they have no clue what they are doing when they talk about the need to calculate and reduce the Bank's emissions profile. 

The only emissions from the Bank that are not covered by the ETS will be those coming from international travel, and maybe if they're getting bank notes shipped in from Canada. The latter will be trivial. Both could easily be offset if the Bank were so inclined. 

The only thing that happens if the Bank decides to take costly effort to reduce its emissions within the cap, efforts above and beyond what would be consistent with basic optimisation that accounts for an expected rising carbon price path, is that ETS credits are freed up for someone else to use. It doesn't make sense to spend $100 to avoid buying a carbon credit that costs $60. Someone else will just buy it instead. But it totally makes sense to spend up to that $60 to avoid buying the credit. 

The Bank calculates its revised carbon footprint at 10,014 tonnes. At $60/tonne, that's just over $600k in carbon charges. I wonder whether they spent $600,000 on reports calculating their carbon footprint. 

A future government that cares about having a Reserve Bank that knows its core business, and sticks to it, will have a bit of a job ahead of it.

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