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When Central Banks Go Green

On a challenge as large as climate change, there are financial risks associated with making the shift to a low-carbon economy, and there are risks tied to inaction. Central banks thus have no choice but to focus more closely on the issue, with or without an expansion of their traditional policy mandates.

NEW YORK – Central banks confronted with the issue of climate change face a number of questions. Should monetary policymakers (and other financial regulators and supervisors) focus on the implications of climate change for financial stability? Should they treat climate change as a potential threat to their ability to pursue their macroeconomic mandates of full employment and/or price stability? Should mitigating the adverse consequences of climate change become an explicit monetary-policy objective?

In considering such questions, it is important to remember that two distinct types of financial risks are associated with climate change. The first includes the transition or mitigation risks that come with a successful shift to a lower-carbon future. For example, climate-mitigation and green-energy policies could result in stranded assets – namely, fossil-fuel reserves – that would sharply decline in value, owing to a fundamental change in demand wrought by legislation, regulation, taxation, technology, tastes, and so forth.

The second class of financial risk concerns a failure to address climate change effectively. There are physical risks associated with adaptation to a higher-carbon future, including the destruction of real commercial and natural assets as well as human capital. A wide range of natural disasters would threaten infrastructure, other privately and publicly owned structures, land, and water resources. And the heightened risks to people of injury, death, or lost earning potential could have adverse financial consequences not just for those directly affected, but also for insurance providers and other parties.

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