15 February: To quantify the impact of “green” monetary and supervisory policies of central banks we develop a dynamic General Equilibrium Model for Sustainable Transitions (GEMST-1). This enables us to make a distinction between green and dirty final subsectors and fossil and renewable power sectors and take into account the feedback loops across sectors through energy prices until 2050. We identify four instruments (capital requirements, collateral frameworks, Asset Purchase Programmes, and Refinancing Operations) of central banks that can lower the cost of capital for climate-friendly investments and thus accelerate the energy transition and lower climate risks. We run three scenarios of different green central bank policies where the cost of capital of green final sub-sectors and/or renewable power sectors is lowered by an ambitious 100 basis points. Our analyses show that the maximum impact of such policies is achieved when it is implemented on both green final sub-sectors and renewable sub-sectors at the same time. Moreover, our study finds that green central bank policies can substantially accelerate the transition with a climate contribution that amounts to 5% -12% of the needed emission reductions under an ambitious climate action scenario. Whereas this is a substantial figure, it also indicates that green central bank policy should be seen as a compliment, not a substitute for fiscal and regulatory reports.
Projects: CFR3-MA
Quantifying the impact of green monetary and supervisory policies on the energy transition
As we transition our economies to a low-carbon path, climate-related transition risks to the financial sector pose a challenge to policymakers in their policy design. Central banks can play an essential role in facilitating a successful transition by directing the funds needed to achieve this transition in a timely manner and thus reducing systemic risks. However, any intervention by central banks should be evaluated across sectors and across scenarios in order to guarantee effectiveness, efficiency, and coherence with fiscal policies.
Our methodology is scenario analysis based on a modified Computable General Equilibrium model, which allows us to capture feedback loops across sectors, along with tracking the change in prices and quantities following an exogenous change in policies, technologies, or consumer preferences. Moreover, in order to capture both risks and opportunities associated with the transition process, our model distinguishes between clean and dirty subsectors. It also uses sector-specific capital stocks, which allows us to differentiate the cost of capital across sectors and scenarios. The model output includes quantitative effects of exogenous policy change on cash flows, return on invested capital, asset values, price levels, inflation, and many other variables across modelled sectors and scenarios. Such information can be used to stress test investment portfolios and financial stability under different monetary, supervisory, and fiscal interventions. We believe that our approach is an innovative one that contributes to answering key questions about the impacts of central banks’ policies and operations on the costs of different pathways for the energy transition, through both the performance of the financial system and the possible changes in the real economy.