Noah Berger/AP Photo
The Dixie Fire flaring in Plumas County, California, last month. So far, the Fed has been extremely reluctant to address climate risk.
This morning, Federal Reserve chair Jerome Powell speaks at the annual economic symposium in Jackson Hole, Wyoming. It’s probably Powell’s last major address before President Biden decides whether to reappoint him for another four years as chair.
The Prospect has spilled a lot of ink over the Powell reappointment, even hosting a roundtable debate on the topic. Defenders of Powell point to his breaking the hawkish stranglehold on monetary policy and moving it toward the direction of full employment; detractors point to a record of indifference at best, and active harm at worst, on financial supervision.
I haven’t really waded into the debate, but my general view is this: Since we must channel the prodigious powers of the Fed at what will almost surely be the most consequential and potentially catastrophic circumstance of the 21st century, the smartest choice for the position is Bill McKibben.
I’m only half-joking. If pressed, every participant in the debate over Powell’s reappointment would have to acknowledge that the climate crisis is the existential crisis of our era. The full arsenal of policymaking must be employed, to make up for the failures of the past and mitigate the worst outcomes. And the Federal Reserve happens to hold some of the sharpest tools in that effort. Yet the Powell debate has focused on his merits in monetary policy versus financial regulation, though climate factors into both.
Climate change presents physical risks to financial assets tied to homes or infrastructure in the line of fire of extreme weather events, whether bonds or insurance claims. And climate change presents transition risks, as the economy shifts to green energy and financial assets tied to fossil fuels suddenly become worthless. Managing both sets of risks—which the Roosevelt Institute more properly describes as “harms”—falls directly within the Fed’s mandate, though you wouldn’t know that from its performance in recent years.
The Fed is failing at the most basic level to counteract the greatest threat mankind has yet seen.
Powell has been extremely reluctant to address climate risk, right up until the moment Biden was elected as president. Prior to that, Powell had consistently stated that climate is “a responsibility that Congress has entrusted to other agencies.” The Fed’s November 2020 Financial Stability report stated, “Climate change adds a layer of economic uncertainty and risk that we have only begun to incorporate into our analysis of financial stability” (emphasis mine). The May 2021 report had nothing on climate.
Only post-election did Powell allow the Fed to join the Network for Greening the Financial System, a coalition of central banks dedicated to policymaking around the green transition. Forty-eight other countries were part of the NGFS before the United States. Also since Biden’s inauguration, the Fed gave a presentation acknowledging climate-related risks to financial stability, and established a “Supervision Climate Committee” and a “Financial Stability Climate Committee.” But this hasn’t progressed beyond talk; nothing concrete has been done.
The organization Oil Change International released a report this week assessing 12 central banks on the measures they have taken to reduce the amount of fossil fuel pollution in the atmosphere. The Fed was found to be “grossly insufficient” on nine of the ten criteria studied; on the other, there wasn’t enough data to make an assessment. This put the Fed dead last among the central banks in the analysis. The report noted that there is no published Fed research on climate risk, and no established definition for sustainable finance. The poor grade was consistent with other green-group assessments.
It’s not like the Fed has nothing to do on this score. U.S. banks have provided far more fossil fuel finance than any other nation’s, over $1.2 trillion from 2016 to 2020. These investments have increased even as the science of climate change became more undeniable. Bank lip service to “net-zero” targets aside, the climate risk already in their portfolios is massive.
Powell’s defenders make it seem like climate hawks want the Fed to go on a spree of direct green lending, favoring certain businesses over others in ways that would not fit with its legal mandate. The truth is that there are many other options available to the central bank, not just to encourage a transition to renewable energy, but more importantly, to manage that transition so financial institutions don’t get stuck with useless assets, threatening their overall balance sheets.
For one, the Fed can incorporate climate risk into stress tests of large financial institutions, as France and Japan have already done. Just as bank balance sheets should be tested for the ability to weather the impact of a recession, they should be able to withstand extreme sea level rise and a rapid shift to renewables. The Fed can also “risk-weight” carbon-sensitive assets, establishing higher capital requirements for holdings in coal plants, for example. Financial supervision can make climate preparedness a major component, and force that information to be made public. (The Fed has reportedly asked banks to explain their climate risks, but has kept its questions and the banks’ answers secret.)
Climate is too important to leave to someone inside the Fed bubble.
This week, Evergreen Action, a new organization with close ties to the president, outlined five steps for the next Fed chair on climate, and it includes mandatory climate-risk disclosure for supervised financial institutions, frequent climate stress tests, and higher capital requirements on carbon-intensive assets. Evergreen also recommends that the Fed actively set “portfolio limits” for regulated financial entities to force divestiture of carbon assets, and that it update the Community Reinvestment Act to assess how banks are making climate-related investments in low- and moderate-income areas.
The Fed can also use monetary tools to target climate, including with its asset purchases. Many have criticized the central bank for its pandemic-era lending and bond-buying operations, which disproportionately helped to bail out the oil sector. The Fed even changed the terms of one key lending program to benefit the industry. This did not appear to honor any principle of sectoral neutrality; if anything, it weighted more toward oil and gas.
Fed officials could certainly commit to future purchases of only stable assets, which could be defined as ruling out carbon-sensitive ones; the Bank of England has already done this. The Fed could also require financial institutions seeking cheap lending through the discount window to offer more collateral if their balance sheet is carbon-heavy. None of this suggests the Fed should start financing the green transition, although maybe it should. The point is that, even before you get to designing new authorities and facilities, the Fed is failing at the most basic level to counteract the greatest threat mankind has yet seen.
Powell is only at the “say pleasing things” stage of seriousness on climate, and even there he said in June that climate wasn’t a “main factor” in the Fed’s policy decisions. I don’t know how that’s close to acceptable. Maybe you think that the Biden administration’s proposed reconciliation bill, with its focus on clean energy and vehicle electrification, will do enough to reduce fossil fuels, so the central bank won’t be needed. But that’s the opposite of what Powell boosters are saying about the need for him to stay to ensure full employment, despite a fiscal policy seeking to put trillions into ordinary people’s pockets. And anyway, if Biden does succeed in shocking the energy sector into going green, the Fed will still have to manage the transition risk, and Powell has not shown that he should be trusted with that effort.
I’m not as convinced that Lael Brainard, the Tim Geithner protégé whom the progressive world has gotten religion on, would necessarily shock the Fed out of lethargy on climate either. Her name has seemingly been floated because Powell opponents judge her the most acceptable to Biden should he desire to make a change. But climate is too important to leave to someone inside the Fed bubble.
No, I don’t actually think Bill McKibben would leave university life to run a central bank, nor should he. But there are other options. In 2015, another central bank chair gave a prescient speech about the “tragedy of the horizon,” how governments find it hard to address problems outside the business and political cycles. His name was Mark Carney, governor of the Bank of England and before that governor of the Bank of Canada. Under Carney’s tenure, the Bank of England has mandated bank climate-risk disclosure, and is leading the way on responding to a net-zero economy. A free agent and climate leader like this might welcome maximizing his impact in the United States.
Whoever the selection, they must recognize how intertwined their role is with the future of the planet. The Biden administration, after a promising start, hasn’t followed through on climate, from the president calling on OPEC to expand drilling to lower gas prices, to oil and gas drilling increasing on public lands during his tenure. They cannot afford any more missteps. In May, the White House issued an executive order on climate-related financial risk. This is obviously a priority for them. With the Fed chair appointment, they need to act like it.
