Megan Greene is a senior fellow at the Harvard Kennedy School of Government and was formerly the global chief economist at Manulife John Hancock Asset Management. Megan is also a returning guest to the podcast and rejoins David to talk about the prospects of central bank digital currency as well as how to conduct climate change policy from a central banking angle.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Megan, welcome back to the show.
Megan Greene: Yeah, thanks for having me.
Beckworth: Well, it's great to have you back on. And last time we were talking about the TLTROs, Eric Lonergan was also on the show with you. Great show, we'll provide links to it. Encourage our listeners to go back and check it out if they haven't already. But you are also working on a book I think last time we chatted, a book on inequality. So tell us about that, remind the listeners what they can expect from your book.
Greene: Yeah, that's right. I'm looking at income and wealth inequality mostly in developed countries, within countries. And I'm looking at all of the new drivers of income and wealth inequality that you wouldn't have learned about if you learned economics 30 years ago, for example. So I'm checking out all these macro and micro drivers and coming up with possible ways to address inequality for governments, for businesses, and also for central banks where they can get involved as well.
Beckworth: Okay. And what's the expected release date, do you have that?
Greene: I don't have an exact release date. I'm almost done researching everything, and I've written more than half.
Beckworth: Okay. Well, we're looking forward to that, and you will be back on the show for sure to discuss it. Very exciting. It's always a treat to get you on. And I must tell the listeners, Megan was very generous with her time. I asked her to come on, I wanted to talk about central bank digital currency. I wanted to talk about climate change in central banking, and Megan's a perfect individual. She's very knowledgeable and very willing to participate on the show with me on this. So Megan, let's start with central bank digital currency, CBDC for short. And you had a recent column in the Financial Times titled, *Central Banks Need to Go Slow on Digital Currencies.* So walk us through that, what's happening and why should they go slow?
*Central Banks Need to Go Slow on Digital Currencies.*
Greene: Yeah. I’ve ended up being sort of an apologist, an apologist for the Fed’s foot dragging on central bank digital currency whereas most people are actually really criticizing the Fed and saying they're missing the boat. And so I'd say the consensus view is that we desperately need a central bank digital currency to address all of these different issues. And part of my argument is that there are so many different issues we're trying to address with one thing. It's not clear that this one thing is actually the best tool to use or that it will achieve what we're trying to achieve with it. I think some of the urgency for central bank digital currency really comes out of, first of all, Facebook's Libra announcement, scared the bejesus out of central banks. That's a technical term, the bejesus.
I'd say the consensus view is that we desperately need a central bank digital currency to address all of these different issues. And part of my argument is that there are so many different issues we're trying to address with one thing. It's not clear that this one thing is actually the best tool to use or that it will achieve what we're trying to achieve with it.
Greene: And then a whole host of other cryptocurrencies have really risen, we've seen it particularly during this pandemic. They've risen in volume and in value. And I think that central banks are a little bit worried that all of the traditional functions of banks, which central banks supervise will move into the private sectors. So central banks won't actually have any influence on those things like lending and deposits or credit extension. And so central banks are keen to set something up so that they don't lose control of that. I think also China is seven years on in its exploration of issuing a central bank digital currency, it's running pilot programs. And so I think there's some concern that we might lose out to China. China is a first mover. Though I should say that a few central bank digital currencies have been issued amongst really small countries in the Caribbean. But among big economies, China's a first mover.
Greene: And so there's some talk about how we could lose the US dollar as the global reserve currency if China succeeds with this. I'm not actually worried about that, I think network effects mean that we'll maintain king dollar for quite a while. So those are some of the motivations. And then also I think there is a real sense, and it's a valid one that our payment system is just not that great. It's pretty slow, particularly cross border payments, it's really expensive. And there are also concerns that not everyone has bank accounts. And so maybe a central bank digital currency could be a way of being more inclusive. So this is a veritable laundry list of things that we're trying to address with one tool and one tool only. And I think it's worth considering whether it's actually the best one. And while functionally a central bank digital currency is meant to make payments systems and services cheaper and better for more people, it might actually achieve the opposite of that if we don't design it very carefully.
Beckworth: Yeah, that's interesting. You answered my question, why are they pursuing it now? You gave this laundry list. And one way of asking this question would be, are they responding to some public demand for it? And what I'm hearing you say is it's more of a supply side driven thing, they're trying to get ahead of the game, responding to all these potential requests. Is that fair?
Greene: Yeah, I think that's fair. And I think there's been very little done on actually selling this to regular people. And I think for Joe six pack, the difference between a central bank digital currency and a regular currency that you can move around digitally is not actually that clear because from their end the effect is kind of the same. So I don't think this is a demand driven process at all, I think it's central banks trying to address a bunch of things.
I don't think this is a demand driven process at all, I think it's central banks trying to address a bunch of things.
Beckworth: Yeah. So they want to stay ahead of the game, they want to get out there before Facebook does, they're responding to pressures from China. There's advocates calling for citizens and businesses having access to the Fed’s balance sheet. So along those lines, you mentioned in your article there's different types of central bank digital currency. There's a token based, and then there's the Fed account type based. So walk us through that. And where would you come down if you had the magic wand to determine which form of CBDC there is? How would you design it? How would you choose it?
Designing An Ideal Form of CBDC
Greene: Yeah. So there are a couple of questions that we need to ask when designing a CBDC. One is whether it's just for businesses or if it's also for just regular people, so retail CBDC. And I think the general consensus is it should be for everyone. Particularly insofar as inclusiveness is the goal, then making it retail makes sense. Then there's a question about who holds the accounts really? So will people just have accounts directly at the central bank? Will I have a deposit account for CBDCs at the Fed, for example. In which case banks don't really have a role to play anymore and the intermediation that they always have. And after the global financial crisis, banks got a really bad rap. And so some people have said, "Well, that's perfect, we don't really want banks to be so powerful."
Greene: But actually there are all kinds of knock-on effects I think from basically decimating the banking sector. And if you want to do this practically, then the central bank has to pick up a whole bunch of different areas of expertise that they've never been involved in before. So they have to do all kinds of credit risk analysis. They have to get whole teams to deal in know-your-customer legislation, anti-money laundering mechanisms. So is the Fed really going to hire up all these people so that they can provide the operations on these accounts? I think that's pretty unlikely. And so more likely I think you'll end up having accounts held at regular commercial banks, but obviously it's the central bank that's providing the funds for them. And so that sort of an indirect model.
Greene: And then you can draw on the operational expertise of regular banks to manage these accounts. That has some problems too, though. So I think it's the better option, but you have to assume that if you can actually get direct central bank money, some people are going to want to do that more than having cash from a bank because banks can fail at the end of the day whereas the central bank can't really. So a CBDC is going to be fundamentally safer than your regular cash in a commercial bank. Some of the regular deposits of commercial banks are going to flee into the CBDC, into these other accounts that the banks will be managing. But that kills off commercial banks' business models because what they do is take their very stable in normal time depositor base, and they leverage it and extend loans into the real economy.
And if you want to do this practically, then the central bank has to pick up a whole bunch of different areas of expertise that they've never been involved in before...you have to assume that if you can actually get direct central bank money, some people are going to want to do that more than having cash from a bank because banks can fail at the end of the day whereas the central bank can't really. So a CBDC is going to be fundamentally safer than your regular cash in a commercial bank.
Greene: So if their deposit base is smaller and not as stable, they won't be able to lend as much. So there is a question about who's going to provide all the lending in the economy. Could it be the central bank? Well, central banks really don't want to get involved in picking winners and losers under any circumstances. So that doesn't seem like a great option. You could also say, well, then the central bank can go ahead and take the deposits that left commercial bank accounts and went into CBDCs and lend them back to the bank. So that central bank becomes a lender of first resort instead of a lender of last resort, in which case the central bank is going to have to do all kinds of risk analysis to figure out which banks they should give how many deposits. Again, the central bank doesn't really have that expertise or really want to get involved in that business.
Greene: So this is a real challenge. And if banks can't rely on their traditional business model of taking deposits and lending them out to make money, they're going to have to make money elsewhere. And so while one of the points of setting up a CBDC is for cheaper services, banks might actually make up what they're losing because of CBDCs by charging more for accounts or charging more for these services. In which case, ironically, you could end up seeing people paying more for payment services than they already are, which is the opposite of what we're trying to achieve. So I think it makes sense to have banks administer these accounts, but there are some real challenges that we're not totally sure how to get around. Then there's another question about how you authenticate with CBDC.
Greene: So you can either authenticate the CBDC itself, so you can either make sure that cash is really cash. In which case transactions can be done totally anonymously like they can with cash right now. But that has challenges because of money laundering. One of the reasons money laundering is so difficult right now is they need cash to do it in a totally untraced format. And that means you got to carry around briefcases dashed with cash, and that's cumbersome and it's easy to get busted. But if it's all digital actually, that gets rid of that impediment. So understandably central banks aren't really keen on that option for authentication, in which case you could end up authenticating the account sort of like we do with bank accounts.
Greene: But then central bank has insight into everything going on in your account. And so while we know central banks are independent in most countries, not all, but in most Western countries, and they're not the same as the government. There are real concerns for a lot of people who don't understand that distinction that this quasi government agency can see everything that they're spending and everything that they're earning. And are they going to get busted on taxes, for example, if the government has total granular details on their accounts? So if one of the goals is to include people and encourage more people to hold these bank accounts, I think a lot of people will be put off by those privacy concerns.
Beckworth: Yeah. I think you're speaking to a bigger point here, and that's our Western values both in terms of privacy but also in terms of private enterprise, letting banks be businesses and do their business and to flourish. And the concern is where we're opening up a Pandora's box potentially if we have these CBDCs, all those areas may be affected. Another one, and Megan correct me if I'm wrong here, but another one that has concerned folks is innovation. So banks have a profit motive, they have the incentive to create new products, to innovate, to bring in the latest technology. Would the central bank have that same drive, that same incentive? Would they be able to innovate like a retail bank does?
There are real concerns for a lot of people who don't understand that distinction that this quasi government agency can see everything that they're spending and everything that they're earning... I think a lot of people will be put off by those privacy concerns.
Impacts on Innovation and Real-time Payments
Greene: Yeah, they probably wouldn't. Some might say that that's a feature and not the financial innovation that got us into trouble for the global financial crisis. So some might say, "Well, it's great if banks just become service providers and aren't innovating so much." But you're right, central banks wouldn't step in to fill that gap. It would be tech companies though that can step in and fill that innovation gap. In fact, they already are to some degree. And so some of the technology behind cryptocurrencies in particular, so things like distributive ledgers, that can really help out our payment systems. So we can harness some of that even now to improve payments, particularly payments within a country, cross border payments are much more complicated. But we don't actually need a central bank digital currency to do that. It seems like there are good alternatives to a central bank digital currency, in terms of achieving what we want to achieve with CBDCs. And so I think it's worth thinking about whether we actually need this to be what we want to or whether other things might work just as well.
Beckworth: Yeah. So you mentioned in your article stablecoins, it might be one example. But in general, FinTech, FinTech providing services. And again, one of the goals is to reach the unbanked, and maybe they can do that. I've had some guests on in the past who've made the case, allow FinTechs to have a Fed master account, allow them to have access to the Fed’s balance sheet and maybe impose regulations, rules unique for them. But long as people can park their funds there in a very place, relatively cheap, that might meet the very need that they're trying to accomplish with a central bank digital currency. But interesting to see what's going to happen here.
Greene: Yeah, it could. And if we don't ... I mean, one downside of not coming up with central bank digital currencies and not extending the central bank's balance sheet to FinTech firms is that you could end up getting the opposite of what you're trying to achieve with CBDCs, which is cheaper services for more people because of market concentration. Tech is one of the areas in which we've had the most market concentration over the past couple of decades. And so you get less competition then and you end up with monopsonies essentially. And so that could actually be worse for the consumer. Generating CBDCs is a way of at least avoiding that situation.
One downside of not coming up with central bank digital currencies and not extending the central bank's balance sheet to FinTech firms is that you could end up getting the opposite of what you're trying to achieve with CBDCs, which is cheaper services for more people because of market concentration.
Beckworth: Right. So it's complicated, there's no way around it. And there's going to be winners and losers no matter what path we go down. One other quick observation and we'll move on, but I know the Fed is also by law cannot be a loss operator, it has to actually break even. So if this path of central bank digital currency incurs new costs, they have to find a way to cover those costs. And I know for example in the discussion about the FedNow account, the real-time payment system the Fed’s developing, they've had to think about costs because by law they can't just provide this service for free at no cost to the public, it actually has to recoup it. So I'm just wondering if that same consideration is also playing in the back of their minds as they think about CBDCs.
Greene: I think it is, but I think the sense is that it will be so much cheaper to do this through central banks than it is currently through commercial banks that it shouldn't be so difficult to recoup those costs. But yeah, it's definitely a concern.
Beckworth: So Megan, are there any upsides for monetary policy aside from meeting consumer needs and stuff, any implications for monetary policy if we do go down the path of the CBDC?
CBDC’s Potential Implications for Monetary Policy
Greene: Definitely. And this is something that gets a lot less attention I think in debates about CBDCs. But if we actually had these digital currencies, it opens up a whole lot of routes for central banks to engage in things they can't right now, particularly things like getting around negative rates and helicopter money drops, so to speak. So if everybody has an account either directly with the central bank or with the central bank but through a commercial bank, then the central bank has the ability to deposit money into all those accounts in a downturn. So in some ways, I know this is terrifying for every central bank, but in some ways it gives them many more powerful tools to actually address a downturn. They can also levy different interest rates if they want to on these accounts.
If we actually had these digital currencies, it opens up a whole lot of routes for central banks to engage in things they can't right now, particularly things like getting around negative rates and helicopter money drops, so...in some ways it gives them many more powerful tools to actually address a downturn.
Greene: One of the problems of negative rates is we're all operating in cash, we all have deposits in regular banks. We have negative rates and our accounts are with the central bank, they can actually cut the deposit rates into negative territory so that depositors aren't actually penalized for those negative rates. That could be a pretty powerful tool in a downturn as well. So it does open up some real opportunities. This is something that Ken Rogoff actually at Harvard has been talking a lot about, but he's been talking about the potential for using negative rates and how it's difficult to do in the way that our system is set up now. But if we weren't using cash and if the central bank had access to all of our accounts, it would be much easier to implement and could be implemented in a bigger fashion. And so it'd be much more effective than it currently would be.
Beckworth: So it would be easier to implement because we would be holding, even if we had a token-based CBDC, it would be digital, so it wouldn't be physical cash with that constraint. Is that the argument?
Greene: And the central bank has direct access to it. So even if you think about stimulus checks that the Treasury Department mailed out to people or were deposited in some cases for people, there were a whole bunch of people they couldn't actually access because they just don't have their details. And it took a while for that money to get out. But if you wanted to do that in the future, the central bank could hit the button and has access to everybody's accounts. And so it could just make that happen instantaneously, so it'd be faster and more effective.
Beckworth: So one of the things that's nice about the US dollar in physical form is all the countries overseas that have failed states, it serves as a medium of exchange for them. So think back to Zimbabwe when they had the hyperinflation in 2008 around that time and the dollar became a de facto currency, they were just using dollars. Eventually the government said, "Okay, you can do it," they didn't fight back. I wonder if we go to pure digital currency, will there always be some physical cash somewhere or will, in the case of Zimbabwe, would they start using the digital dollar themselves? It's almost like people we provide a public good to the world through the physical cash that it gets exported overseas. Any thoughts on that?
Greene: So I think we'll still continue to use regular hard cash for a long time. Might it disappear at some point? Possibly. But whether you can easily just transfer money into different countries' digital currencies or not depends on your central bank setting up a corridor with another central bank, making sure that the exchange rates are the same within and outside that corridor. And there are over 200 currencies in the world, so that's over 200 bilateral agreements that need to be, A, agreed, and B, administered. And I think that's just unworkable realistically speaking. So in theory, you could get this incredible global system. In reality, I think that's going to be really difficult. So I'm much less optimistic about central bank digital currencies really helping with cross border payments or having massive knock-on effects globally anytime soon, certainly. But I think it's just too difficult to actually administer that many different bilateral agreements.
In theory, you could get this incredible global system. In reality, I think that's going to be really difficult. So I'm much less optimistic about central bank digital currencies really helping with cross border payments or having massive knock-on effects globally anytime soon, certainly.
Beckworth: Okay. Very interesting. Again, we'll provide a link to Megan's article in the Financial Times on central bank digital currency. Let's segue now into climate change for several reasons. The first one, and we'll come back to this later, is that Fed chair Jay Powell, he's up for renomination. Potentially, he may not get the renomination, maybe someone else will. But he's up for it, and progressives have been attacking him. First it was he's soft on the regulatory front, now it's on climate change. In fact, this seems to be the growing focus of their attacks, their criticisms of him. And we'll come back to that in a bit. But it's also I think timely to discuss climate change because there was a recent UN Intergovernmental Panel on Climate Change report that came out this year. And there's a conference coming up here in October for the countries to get together and discuss the findings of this report and what they will do, next steps they will take. So Megan, maybe walk us through some of these recent developments with the UN's report in the conference coming up.
Importance and Highlights of the UN IPCC’s Recent Climate Report
Greene: Yeah. So the UN's report was the first scientific reassessment of climate change since 2013, so it had been a while. And I think the findings were more pessimistic than most people had expected. So it was a real shock, in discussing it, the head of the UN said this was code red for mankind. I mean, that's a dramatic statement. But not given what they found. The whole goal of what was agreed in 2015 when the Paris climate agreement was struck was to keep temperatures from rising too fast. So the goal was to keep temperatures from rising over two degrees Celsius. And this report found that actually unless we change things really drastically immediately, temperatures will rise by at least 3% percent Celsius. And it seems like a small change, but the implications for biodiversity, for all of our ecological systems are pretty severe. This report came out in advance of COP26, which is meant to happen in Glasgow in November, the first half of November in person at the moment, we'll see.
Greene: And it's co-chaired by the UK and Italy. But world leaders are going to get together virtually or physically and discuss how we're going to address this issue that this report has brought up. Now, a lot of countries have come up with really ambitious targets for how much they're going to cut greenhouse gas emissions. Most countries have signed on to a net zero by 2050 pledge. So they won't be generating more greenhouse gases than they're actually absorbing in different ways by 2050. Some countries have been more ambitious than others. I think at the center of COP26 is going to be a bit of an argument between developed countries and emerging market countries because the emerging market countries rightly argue, "Look, it's the developed countries that have generated all of these greenhouse gas emissions, not us. And we're getting a lot of the floods and hurricanes as a result of them, so we want to be compensated in part for having to suffer all the negative effects of their development. But also we need money in order to not increase our greenhouse gas emissions ourselves."
Greene: So a lot of it will be about climate finance. The developed countries had agreed that they would transfer a hundred billion or not a strict transfer, loan or transfer a hundred billion a year to emerging market countries by last year. And they actually hadn't hit that target. So that will be the center of a lot of the debates. I have to say as someone who's involved in COP26 and talking to a lot of the actors, the focus seems to really be on everybody's targets and how they're going to hit them. And less so on hard hitting new ideas for how we can think differently about changing everybody's behavior so we can actually achieve this. I'm a bit disappointed going into it, but hopefully things can change.
Beckworth: So Megan, that's a great overview of what's happening. Maybe just remind our listeners what COP26, the acronym, stands for just in case they want to look it up themselves.
As someone who's involved in COP26 and talking to a lot of the actors, the focus seems to really be on everybody's targets and how they're going to hit them. And less so on hard hitting new ideas for how we can think differently about changing everybody's behavior so we can actually achieve this. I'm a bit disappointed going into it, but hopefully things can change.
Greene: Yeah. So it stands for Conference of the Parties, and 26 suggests how many we've had before. So it's when world leaders get together, and it's climate focused and managed by the UN. So it's a UN process.
Beckworth: So we'll see how that goes, and that's later this year as you mentioned. So we'll be in the news, we'll be following this. Let's take this though and going into the direction of central banking, which is what we talk a lot about on this show, and you yourself have done a lot of work on. And as I mentioned, the big thing right now related to this is the renomination of Jerome Powell as Fed chairman, whether he's green enough and the Fed’s green enough. So let's just step back and think about greening of central banks in general and the pattern that's emerged. Correct me if I'm wrong here, but I'm going to start back in 2017 when the foundation was set with the Network for the Greening of the Financial System, the NGFS. It's an organization of central banks. And 2017, it starts.
Beckworth: And then we've had a number of central banks who've joined them, the Fed most recently this year joined them. It was one of the last ones to join them. And I want to read to you a finding from a survey from the BIS, it took last year, 2020. And this is what it found in the survey. It was on this issue of the greening of central banking. And it found, “a large majority of respondents noted that they do not have an explicit mandate with regards to climate related financial risks. But indicated that such risks could potentially impact the safety and soundness of individual financial institutions and could pose potential financial stability concerns for the financial system. Accordingly, these respondents viewed as appropriate to act within their existing mandates to mitigate climate related financial risk.” So what do you think about that, are central banks overreaching here? Is it reasonable to find ways into the climate change process with the existing mandates they have? What are your thoughts?
Central Banking & Climate Change
Greene: Yeah. So my thinking on this has totally changed over the past I'd say year and a half. I actually wrote a column in the Financial Times that effectively argued that central banks have no business really getting involved in climate change beyond a real supervisory role. You can always get an audience with a central banker if you want to talk about risk, financial risk and climate change. That's easy for most central bankers to swallow. The question is whether monetary policy should really be addressing climate change. That's the much less popular vision. And I actually was against it because I thought central banks have a time horizon of two, three, maybe four years where they're forecasting. And the implications of climate change are much further out than that. And so it's really difficult for them to respond to something so far out given that time horizon. I'd say the climate related events of just this summer alone take that argument out at the knees.
The question is whether monetary policy should really be addressing climate change. That's the much less popular vision.
Greene: I mean, obviously climate change is a crisis right now not 10 years from now. And so I don't think that works. And also I think most central banks feel like it's not their job to do anything about climate change in part because they also feel like it's not their job to pick winners and losers. And traditionally, it wasn't in theory. But actually if you think about what central banks do, all they do is pick winners and losers. If they hike interest rates, they benefit savers and disadvantaged borrowers. If they cut interest rates, they do the opposite, right? So they're picking winners and losers even with their most basic tool, nevermind when they decide that they're going to buy up corporate debt or high-yield bonds. In which case when the central bank announces they're going to buy something, whoever holds that thing wins, there's a clear winner there.
Greene: And so I think now that actually central banks are already picking winners and losers. And if you believe like I do that they're never going to be able to stop, they might as well be thoughtful about it and address one of the biggest crises that we're facing. And by the way, they've done this before. So the Fed, for example, stepped in and basically funded the World War II effort because it was an existential threat. They picked real winners and real losers. And so if you think climate change is as existential a threat as a war, then you can argue easily, I think, that central banks should step in again in the face of this threat.
Beckworth: Okay. So let's talk about what the Fed has done. And maybe we can come back to this issue that you bring up about how central banks are actually doing this, how you can justify what they're doing. Let's talk about what the Fed’s doing, and if it makes sense to you as they pursue a climate change agenda. So they have established two committees. They have a supervision climate committee that looks at microprudential focus. And then they have a financial stability climate committee, which is a macroprudential focus. It was interesting to learn they have two separate committees working on this. And Governor Brainard has a speech from March 2021 this year, and I thought was useful in illustrating how these two committees work differently but can compliment each other. And she gives us an example. She says, “one example is property and casualty insurance, which enables financial firms to engage in financial contracts to hedge climate related risks, while reinsurance contracts and agreements among investors can shift risk across the global financial system. As I noted earlier, some level of risk is likely to remain. A lack of transparency across participants in the financial sector could cause climate related risks to build up in hidden pockets embedding vulnerabilities that could result in cascading losses in the event of large-scale adverse weather outcomes or shocks to asset valuations.” So is that the right way to think about why a central bank should be worried about climate change, it's a threat to financial stability, or should they be thinking broader or more narrowly?
If you think climate change is as existential a threat as a war, then you can argue easily, I think, that central banks should step in again in the face of this threat.
Climate Change’s Impact on Financial Stability and Central Bank Mandates
Greene: Yeah. So that's the way that central bankers can stomach it at the moment is to think about supervision and financial stability and risk. That's the way that central bankers worldwide can engage with this topic. I actually think that they should be thinking in larger terms just because if you think about weather related catastrophes that we've had this summer alone and how they impact local economies that can impact the national economy, the implications for growth and therefore inflation are significant. So I think there's a case to be made that climate change really threatens a central bank's core mandate, which is usually around inflation, and for the Fed is also around unemployment or full employment. I don't think it's just about stranded assets and disclosure, I think that's really important and that can help us address it. But I think central bankers should think about this as threatening their ability to actually achieve their mandates.
Beckworth: So that would include price stability. You think this could actually be snuck in through the price stability part of the mandate?
Greene: I think it could, and actually it has been. For the Bank of England and the ECB in a way, they've made climate change part of their official mandate because it's related to the other mandates that they have.
Beckworth: Well, maybe tell us a little bit more about them. And what exactly have they changed and what are they going to do to meet this change?
I think there's a case to be made that climate change really threatens a central bank's core mandate, which is usually around inflation, and for the Fed is also around unemployment or full employment. I don't think it's just about stranded assets and disclosure...But I think central bankers should think about this as threatening their ability to actually achieve their mandates.
Greene: Yeah. We still don't know. Both the Bank of England and the ECB have had their mandates tweaked to include climate change pretty recently, and so we don't actually know exactly what they'll do with that. But I will say that both the Bank of England and the ECB have done more than the Fed has when it comes to climate change. So the Bank of England has been a real front runner in terms of addressing climate change that was largely under Mark Carney's tutelage. And he's now of course the climate tzar at the UN, so this has always been a pet topic for his. And the Bank of England has been really intent on corporate disclosure of climate risks. So for now it's voluntary. And about a third of companies fully comply with guidelines that were set up for disclosure for climate risk, and almost half partially comply.
Greene: But by 2022, all publicly listed companies will have to disclose their climate risk. And by 2025, privately held companies and asset management firms, insurance companies will have to disclose it as well. And so this gets to what Lael Brainard was saying in that speech that if you have disclosure on these things, then everyone can assess the risks a bit better. And so the chances of having a surprise event that results in a ton of stranded assets, for example, are much lower. So the Bank of England is further along in that. The Bank of England has also run or announced that they'll run some stress tests based on climate change scenarios. We don't have the results of them yet, I think we'll get them next year. And actually the results are going to be pretty soft.
Greene: So in a normal stress test, you see what the results are for every bank and their capital requirements off the back of those results. This won't be like that, we'll get an aggregate level of results and there won't be capital requirements off the back of it. The ECB is not far behind the Bank of England, they're also looking into disclosures, and they've also run a stress test. We don't have the example of the results yet, we should get them. I think very soon actually, it was supposed to be by late summer. And again, there won't be immediate consequences for financial services, institutions in terms of capital requirements, but at least it's a step there. The Fed’s announced that they're starting to think seriously about maybe one day having stress tests involving climate change, just to give you a sense of how far behind the Fed is on this stuff. So they have some ground to cover, but actually it doesn't mean that the Fed will be behind forever.
Greene: The Fed has, as you mentioned, has taken a bunch of steps to try to delve into climate change from a supervision perspective, from a risk perspective. But they could take on board what other central banks have been trying and leap frog. So just because the Fed is a laggard now doesn't mean it always will have to be. I think one reason the Fed has been a laggard is because they're a little bit worried about mission creep really. I think particularly this Fed chairman who after Jackson Hole just over a year ago had angry tweets from the president about his remarks is sensitive to political influence and is sensitive about the central bank's independence. I think there are concerns about the central bank delving into things that aren't really its lane traditionally because what if you get a government in place one day who says, well, if you did that, now you can do this. If you funded or subsidized climate change, now you can subsidize a wall, for example. And I think that's a real concern.
Beckworth: Okay. Well, let's look at some of the ways central banks could do even more. Right now, we're discussing the case for central banks doing actions to help fight climate change. And I want to go over a list that was provided by the Network for Greening the Financial System, again the NGFS. They had a report in March this year. And they go through, and there's three areas where they say central banks could go to the next level, they could pick up their game. One is in credit operations, one is in collateral, and one is in asset purchases. I think you've touched on some of these. But with credit operations, the interest rates you charge would be tied to how green each entity was.
I think there are concerns about the central bank delving into things that aren't really its lane traditionally because what if you get a government in place one day who says, well, if you did that, now you can do this. If you funded or subsidized climate change, now you can subsidize a wall, for example. And I think that's a real concern.
Beckworth: But to tie this back into digital currency, maybe your digital currency return would be maybe tied to how green you were. Collateral, similar thing, the haircuts, the amount of assets you can use would be tied to how green they were. And then finally, asset purchases, outright large scale asset purchases. Maybe they start buying green corporate bonds or something along those lines. So those are all areas where central banks could be more aggressive pushing the front forward and getting there. Any thoughts on those three areas?
Three Areas of Central Bank Improvement on Climate Change
Greene: Yeah. Actually, we have some experience with some of these. I should have mentioned that the ECB does accept green bonds as collateral and also is buying up green bonds. More sovereign green bonds than corporate green bonds. But some national central banks, particularly the French central bank and also the ECB are including green bonds in their asset purchases. So it's a way of providing a bit of a carrot. And I think also you can provide a stick, that's not being done yet. But we could get there whereby if you have gray assets or brown assets depending on your classification, not green assets, then you take a bigger haircut or you have to pay a higher interest rate. And the opposite of that is something that I've been proposing, I think I might've proposed it on the last podcast that I did with you with targeted long-term refinancing operations that the ECB is implementing where you have deeply negative rates that banks can borrow at from the ECB if they use the money a certain way and right now.
Greene: It was if they extended new loans onto the real economy, now it's just if they maintain their loans in the real economy. But you could actually say you can have this really negative rate, you can collect this money if you lend that money on for-green investment. And if you think about where most of our biggest CO2 emissions come from, it's from our housing stock, commercial real estate as well, it's from transportation. We haven't been able to refurbish all of that in part because there hasn't been a financial incentive to. But this would be one way to generate a massive financial incentive. Banks get paid by the ECB to do this, the ECB lends on to the end user, to you to retrofit your house so that it's got better insulation. And you might get a negative rate as well, so you might get paid for it as well under this scheme. So the ECB has the plumbing already established, so does the Bank of England. The Fed does too, it just hasn't used it at all in this way. So it would be a bigger step for the fed.
Beckworth: Well, those are all very interesting suggestions, and we'll provide links to all this material. But Megan, I got to lay my cards on the table here. I'm still with your first article on climate change, I haven't gotten to your second article yet. My heart is still in the first one. It's more out of concerns I think that many central bankers share, it's not an issue about climate change. I think climate change is a big, pressing issue, but I'm not convinced I guess that the central banks are the best agency to deal with it. I think some other federal agency that has funds allocated by Congress would probably have more legitimacy, more ability to do things.
Beckworth: But let me just go piece by piece on some suggestions, and you tell me why these are not sufficient, maybe why I need to think bigger and bolder on the climate change issue. So let's start with financial stability, why not just focus on firms in general funding with more capital, more equity, make them more robust to any shock? Climate change, war, whatever it may be. Why not just focus on enhancing financial stability overall in general and let the chips fall wherever they may be from?
Enhancing Financial Stability as an Alternative?
Greene: So I think that there are maybe two good answers to that. One is if you beef up financial stability, you could seriously curb lending activity. That could be a result or an unintended consequence, which isn't necessarily what we're going for as we're trying to come out of a downturn and is never what you're going for. So as long as they're stable enough I guess is the idea. You want to hit this perfect sweet spot where financial institutions are stable enough but still able to actually engage in lending and credit extension. So you don't want to make them hold more capital, for example, so that they're more stable, but then they've got no capital that they can lend on. That would be a drag on growth.
Greene: So I think that's one reason. And then I think another reason is that we know for sure, I have been saying myself up until six months ago climate change will be an existential threat. And someone finally corrected me and said, "What is this “will be” business? It is already here, it's here." It's not still coming down the pike as I had been saying and many others are. So given that we know that this is an immediate threat, why wouldn't we address it specifically if we've got the tools to do that? I am sympathetic to your argument for what it's worth it that there are other actors who are better placed to do this, definitely.
Greene: So fiscal authorities in theory could do a lot on this, but they haven't. And they haven't for many reasons, one could be that their electoral cycle is not that long, and so they're just not as incentivized to. Hopefully, we'll get more out of the Biden administration on the climate front, I think we will. But also given this is an immediate threat, why wouldn't we try to fire on all cylinders? So yes, the fiscal authorities should absolutely do their job on this. But if central banks can play a role, particularly in the climate finance piece, then why wouldn't we use the tools that they have at their disposal?
Yes, the fiscal authorities should absolutely do their job on this. But if central banks can play a role, particularly in the climate finance piece, then why wouldn't we use the tools that they have at their disposal?
Beckworth: That's a great reply. I'm very sympathetic to something like a National Investment Authority. I had Saule Omarova on the show, and she's proposed something like this which would be useful not just even for this, but it'd be useful during recessions in general. Last year, there's this big debate about the Fed doing credit allocation when it set up all these facilities to state governments, to businesses, to corporate bonds. It may have crossed the rubicon from liquidity to credit allocation. And there were people on the left who were making this comment. And many of them suggested what's needed is a fiscal facility that has the authority from Congress to make those kinds of credit decisions where the Fed doesn't.
Beckworth: But I take your point too though that the Fed is the only game in town many times because there aren't these agencies yet, there isn't the responsibility taken on by Congress. So the Fed is given. But that leads me into my next concern, and that is legitimacy. So Paul Tucker who you know has this great book on the political economy of central banking and government in general. And he makes the case that if a parliament or Congress wants to delegate authority to an agency over some issue, there needs to be public consensus on it. There needs to be agreement this is the direction we're going to go. So a good example would be price stability. Most people agree on the need for price stability of some form. So delegate that to the central bank.
Beckworth: Now, when you come to the environment, he would say in Europe and maybe in England there is consensus, it has to be done. So it's easy to delegate, no question. Here in the United States on the other hand, we're a very polarized country. I mean, there was a close election past two times for the president. And if we delegate that authority to the central bank, they take on more and more. It could be seen as the central bank doing mission creep and not having legitimacy to do it because half the country doesn't support what it's doing. So maybe that's one of the reasons the Fed has been slow to adopt some of these changes, just they don't feel they have the political support behind them. Do you want to respond to that observation?
Questions on Central Bank Legitimacy
Greene: Yeah. So I think it is a concern, but I also think going back to our discussion about how climate change is at the center of the Fed’s actual mandate, the Fed doesn't need more permission, I don't think. And different people have different views about this, but the Fed doesn't need a new mandate given to it by Congress if it's job is price stability and full employment and full inclusive employment. Then climate change can impinge on all of those things. So addressing climate change is part and parcel of the Fed trying to achieve what it has already been asked to achieve. So I actually think that the Fed can already do a lot of this within its mandate.
The Fed doesn't need more permission, I don't think. And different people have different views about this, but the Fed doesn't need a new mandate given to it by Congress if it's job is price stability and full employment and full inclusive employment. Then climate change can impinge on all of those things.
Greene: I know that the Fed would prefer to get permission from Congress because ultimately Congress is the Fed’s boss. So they would prefer to be told that, but then there is also this concern, well, this Congress asked us to deal with climate change, the next one has asked us to do the opposite, and we just all have whiplash at the central bank. And I think that is a real concern, I'm not sure what you can do about that. But like I said, maybe you don't need Congress's approval, maybe you just need to be working on your mandate.
Beckworth: Let me move on to another concern, and that is the politicization of the Fed, and you've already touched on this. But let's say hypothetically the Fed is given power by Congress to start buying green bonds, and it begins to do that. I could see a debate emerging over what is a green bond? How do you define a green bond? It could be something really technical, but it could be something that's fundamentally different as is nuclear energy green or not? There's a debate among climate activists whether nuclear energy, geothermal, should we include those with solar and wind? So any concern on issues like that that the Fed becomes politicized even within the framework or the big 10 of climate activists?
The Politicization of the Fed Within the Climate Debate
Greene: Yeah. So the taxonomy is the hugest issue here I think. And so you really hit the nail on the head that defining a green investment or a green bond is really difficult. The EU comes out with guidelines, they're hundreds of pages long. I don't know anyone who's actually read them, including myself. How is an investor or how is the central bank going to actually upkeep a multi hundred-page document? That's difficult. That being said, I think you've got to start somewhere. And so knowing that we're not going to have it done perfectly at the beginning doesn't mean that we shouldn't do it at all. I think we have to assume that taxonomy is always going to be an issue, but we'll probably improve along the way. This is also at the heart of the ESG movement I think as well as taxonomy, what's a green investment in a portfolio? Whose definitions are you using?
Greene: It's really difficult to come up with a truth with a capital T on that, but that doesn't mean that the movement shouldn't go anywhere. It just means we're going to have to do the best we can and work it out along the way. And so there is some opportunity for politicization, but I think that's uniform across the board that this is just a challenge for every central bank, and we kind of have to do the best that we can. There are opportunities for greenwashing, there is greenwashing absolutely. That is a shame, and hopefully that will diminish as we get better and better-
Beckworth: What is greenwashing?
There is some opportunity for politicization, but I think that's uniform across the board that this is just a challenge for every central bank, and we kind of have to do the best that we can.
Greene: So greenwashing is saying that something's green when it really isn't so much or saying that a firm is net zero when it's not actually or it only is based on this kind of particular definition that you've chosen to make it so. So that's called greenwashing, and it happens a lot. But just because it happens doesn't mean we should forget it and give up altogether. I think it just means we're going to have to accept that we're going to get better at this as we go along.
Beckworth: It's kind of like buying organic foods, sometimes those labels don't mean what they say, but you still want to try to get the organic food if you're concerned about health issues and stuff. It's a learning process. Okay, fair enough. All right, let me bring up another point, and this may seem a bit silly, but I've heard this point made. And I did a tweet recently, a reductio ad absurdum tweet illustrating this point. But how do we define existential threats? So climate change certainly seems to fit that, but this is like a long haul threat. This is a process that will take years. You used the analogy of war, which I think is a fair one. When it's war, you go all out.
Beckworth: And even last year would be a good analogy too, this pandemic was a war, a public health war. We went all out, the Fed bought up a lot of government debt, help support what was going on. But why couldn't I point to say the threat of an asteroid hitting planet earth, why don't we spend money? Alex Tabarrok is a good friend of mine, he thinks the government should spend more funds preparing for defenses for asteroids. If I had to look abroad what would be the biggest existential threat and foreign policy, maybe nuclear war with China. How do I draw the line between legitimate existential threats and just ones that are on the horizon not to worry about here and now for the Fed?
Addressing Existential Threats
Greene: I don't have a perfect answer for you, but I think you have to look at two components for all these threats. One is impact, so how bad is that existential threat? And the other is probability. And you've got to come up with some kind of calculation based on the two of them. And if probability and impact are both high, then we should probably do something about it. I don't know much about asteroids, but I don't think the chances of an asteroid hitting earth and decimating us are that high. Though if it happened, it could be really bad. But overall, that score wouldn't be that high relative to climate change where the probability is incredibly high already and the impacts also are pretty high.
Beckworth: That's a great way of thinking about it, probability in an actual impact. So maybe it'd be neat to have someone to come up with a list of existential threats with a score calculated and rank them top to bottom. That would be very useful, I think actually they have something like that. Megan, one other objection I have to tying the climate change into the Fed’s mandate and particularly price stability mandate because I've heard that several times that climate change could make things more scarce, more expensive, prices go up, which is totally true. In fact, we have seen this with the pandemic. The pandemic is also a negative supply shock. Climate change would be a big, big, negative supply shock to the global economy. Things would get scarcer and more expensive.
Beckworth: But when we think about what the Fed is aiming to do, it's aiming to stabilize trend inflation, like inflation over many, many years. And I see what we have happening now, in fact, the whole transitory versus permanent inflation story. So climate change could make things more expensive, it'd be more of a one-time bump or maybe multiple bumps. I don't think it would be a change in trend inflation or am I wrong here?
Climate Change and Trend Inflation
Greene: I think it could be a change in trend inflation, it would just take us to a different plane, I think. If you assume that climate change isn't a binary thing and that our planet is heating up by 0.1% Celsius every so often, there are different implications. Initially it's a bit harder to grow food and a bit harder to get water. And as the temperature goes up further, biodiversity falls even more, and these things get worse. I do think you end up with incremental changes and all kinds of wildfires and things like that that are supply shocks. But I do think it could put us on a different sort of plane for trend inflation as well.
And as the temperature goes up further, biodiversity falls even more, and these things get worse. I do think you end up with incremental changes and all kinds of wildfires and things like that that are supply shocks. But I do think it could put us on a different sort of plane for trend inflation as well.
Beckworth: So you're saying it'd be more than just one shock, it'd be multiple shocks each of which would cause prices to go up, and therefore it would be more than just a one-time pop, it would be a sustained growth in prices over a long period.
Greene: I think so. In so far as climate change isn't binary, it's going to be an experience unless we do something about it where things get incrementally worse.
Beckworth: Okay. So we're on this journey called climate change and how to deal with it. And we've had a great discussion today with you Megan on this and the role that central banks can play. So what would you like to see as the next steps moving forward? What should the Fed, what should the ECB, what should the Bank of England, Bank of China, what should they be doing next steps to get us to the place where we need to be?
Next Steps for Addressing Climate Change
Greene: So I think they should continue considering the financial stability side of this, but I think they should also figure out how they might provide finance to retrofit our lifestyles so that they're more sustainable. And there the central banks sort of uniquely have an easy role to play I think by saying we'll subsidize this stuff, go out and do it. And I think people would do it pretty quickly if it were subsidized. I would love to see that happen. And alongside that, I think there's a real reticence on behalf of regular people to recognize that our lifestyles have to change fundamentally if we're going to get on top of this. But if you were to provide finance to help us get there, then people might be more willing to go ahead and adopt new practices and make their houses more green and their transportation more green as well. So I think central banks could have a quick and easy role to play if they could get there.
I think they should continue considering the financial stability side of this, but I think they should also figure out how they might provide finance to retrofit our lifestyles so that they're more sustainable.
Beckworth: In the time we have left then, are you optimistic? Is the glass half full, half empty? I mean, not only central banks, the role they play, but in general technology, innovation, things that can make the world a better place on this issue. So I recently had Arthur Turrell, he used to work at the Bank of England. He's also a nuclear fusion scientist, I guess he's technically a plasma physicist. And he has a new book out, it's really great. And man, it made me very hopeful that nuclear fusion could be just around the corner. It's cleaner nuclear energy, it's also very abundant. It would solve a lot of problems if you could commercialize it. Now, we're not there yet. Any thoughts you have in closing here on whether we should be seeing the glass half full, half empty, what's the outlook?
Greene: I think those who are really optimistic about this are usually relying on new technologies to come and help us figure out how to trap carbon underground or spray the atmosphere with some sort of new chemicals that aren't bad so that it protects us from all these emissions, things like that. I'm not a scientist, I don't know enough about those technologies. I think I can't rely on those emerging, it would be great if they did, and I would be more optimistic if they did. But I think I'm more cautious. I think since those don't exist yet, we've got to do what we can with the tools that we have. I guess I'm optimistic but really worried.
Beckworth: Fair enough. Well, our time is up, our guest today has been Megan Greene. Megan, thank you so much for coming back on the show.
Greene: Always a pleasure. Thanks for having me.
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