Change is afoot at the Reserve Bank of Australia. This week the Treasurer announced Michele Bullock will take over from Philip Lowe as Governor of the RBA. Lowe had faced mounting political heat after he abandoned forward guidance given as late as November 2021 that interest rates would not rise until 2024 and joined central banks around the world in rapidly hiking interest rates.
One of Bullock’s first tasks will be to oversee the implementation of the recommendations of the Review into the RBA released in March 2023. Most attention about the Review has focused on its proposed structural changes to the RBA, which would create separate boards for monetary policy decisions and institutional governance. This change will bring the RBA in line with many of its international peers. Last week, outgoing Governor Philip Lowe announced initial steps towards implementing this recommendation.
But in one important area, the Review’s recommendations will leave Australia’s central bank falling behind many of its international peers. The Review considered whether the RBA should play a more active role in climate policy. Although the Review affirmed the RBA’s recent moves to incorporate climate risks in its analysis of the economy and the financial system, it explicitly recommended against the RBA using its monetary policy powers to reduce the risks of climate change.
In the words of the Review: “The Government should not make transition to a low carbon economy an explicit objective of monetary policy.” The Review reasoned that climate change was the responsibility of elected government, whose fiscal and regulatory tools could be more effectively deployed to drive decarbonisation.
In making this recommendation, the Review sided with comments by Jerome Powell, Chair of the US Federal Reserve, who stated in January that “We are not, and will not be, a climate policymaker.” However, other central banks, such as the Bank of England and the European Central Bank, are beginning to recognise their role in addressing climate change, and have taken steps to green their policy frameworks.
The original terms of reference for the Review did not mention climate change. That one of the Review’s 14 recommendations was about climate change reflects the growing calls for central banks around the world to take climate change seriously. The Review itself notes the submissions it received and consultations it conducted made it clear that climate change is a community priority.
The Review talks about climate change through the lens of ‘climate risk’. In this framing, climate change is understood as a risk to financial stability. An influential report released in 2020 by the Bank of International Settlements – the international institution owned by central banks including the RBA – found that climate change risks could be “the cause of the next systemic financial crisis”.
Thinking about climate change as a financial risk is focused on capturing the risks of climate change to the financial system. Those risks are two-fold: the physical risks of climate impacts such as rising sea levels or prolonged drought, or the transition risks of societal responses to climate change, such as climate policy setting stringent emissions targets.
Climate change, of course, is more than a financial risk; it represents a grave threat to life itself. Nonetheless, understanding climate change in this way is placing it on the agenda of central banks around the world.
Monetary policy decisions such as whether to increase or decrease official interest rates have important implications for climate change, by affecting the cost of borrowing for green and fossil fuel investment, alike. Climate change, in turn, has implications for inflation, as higher temperatures and more frequent and intense natural disasters can make the price of goods such as food higher and more volatile – a phenomenon that has been dubbed “climateflation”.
The relationship between climate change, inflation and interest rates has led to questions about whether the mandates of central banks should be extended to cover climate change. The Bank of England has moved in this direction. In 2021, in addition to the 2 per cent inflation target, the Chancellor added the “transition to a net zero economy” to the Bank of England’s remit.
Other central banks have also considered how their broader financial market operations may be inadvertently supporting fossil fuels, and how they could instead support lending for green investment. The European Central Bank has recently announced its intention to adopt climate criteria in the management of its own balance sheet and in its provision of liquidity to the banking sector.
Central banks like the Bank of England and the European Central Bank themselves need to go much further on climate change. But their openness to play a role in climate policy points to a future in which central banks will not be able to resist calls to use their monetary policy powers to respond to climate change. In contrast, when Philip Lowe last week announced changes in response to the Review, he confirmed it would be business-as-usual when it comes to climate change, stating that “the Bank will continue with its current approach to climate change analysis.”
There are important differences between the RBA and other central banks that mean policy frameworks cannot simply be transferred across countries. A key issue in Australia is the division between the RBA and APRA, the separate authority which handles macroprudential regulation and financial supervision. In June APRA added “climate-related risks” to its Statement of Intent for the first time.
The Review missed a significant opportunity to outline what a modern role for the RBA in addressing climate change and supporting a low carbon transition, in coordination with fiscal and regulatory authorities, should look like. Incoming Governor Michele Bullock now has an opportunity to correct this mistake and chart out a course that would position the RBA as an international leader on green central banking.
Philip Lowe’s forward guidance on interest rates was made in the context of a pandemic-induced crisis that carried significant risks for the Australian economy. However, it was based on a model of the relationship between inflation, wages and employment that no longer reflects the reality of contemporary capitalism. The RBA should not make a similar mistake with climate change by treating it as a problem that falls outside boundaries of a monetary policy framework that remains unfit for purpose in a warming world.
Image credit: Crawford Australian Leadership Forum