Opinion: How the Fed could give a green light to environmentally sustainable investments

BOSTON (Project syndicate) – The Federal Reserve has taken a number of climate-related measures Announcements Joined the Financial System Greening Network in December and then in recent months Definition a new monitoring climate committee in February. While these are important first steps, the Fed should do more to address climate change, which in turn can help fulfill its mandate.

Although President Joe Biden has made it clear that climatic considerations will affect his administration’s overall budgetary decision, this does not take the central bank off the hook. However, the Fed is concerned about its independence and is concerned about using the unconventional tools required to get monetary policy on the same page.


Now that the Federal Reserve has started to speak more openly about climate change, it should dig deeper into the tools it already has at its disposal to contain the problem. Some green monetary policies will turn out to be both environmentally and economically beneficial.

The Fed has gone well beyond manipulating overnight bank lending rates (the benchmark for borrowers and savers across the economy) and has plunged deep into unconventional waters, for example when it bought Assets began. They say it doesn’t want to pick winners and losers, but it already does: anyone who holds assets that the central bank buys becomes a winner.

Opinion: Central banks don’t have to pick winners and losers to fight climate change

Legal Restrictions

Even if the Fed were willing to fully incorporate climate change into its monetary policy, its actions would remain legally constrained. The central bank can only buy obligations from the US government directly through open market operations or quantitative easing (QE) programs. To get a specific asset class – such as B. Green Plants – to support it directly, it would have to get permission from the Treasury to call it up Section 13.3 of the Federal Reserve Act.

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However, the Fed can get around these restrictions by encouraging private banks to steer their lending in a certain direction. The Fed charges banks for direct lending through their discount window, and that discount rate is currently above the federal rate. As a result, any bank that borrows through this window will have to pay a premium, raising suspicions that they would only do so if they were in trouble. But this does not have to be the case. In the 1970s and 1980s the discount rate was below The Federal Funds Rate and the Fed could effectively subsidize banks that borrowed through the discount window by lowering the discount rate deep into negative territory.

To encourage green investment, the Fed could mandate that funds borrowed at a preferential rate at the discount window must be used for a climate-friendly cause. Maintaining a positive interest rate on bank loans could ensure that the introduction of negative interest rates does not put savers or banks at a disadvantage.

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Targeted lending

There is already a precedent for such targeted lending. After the global financial crisis, the Bank of England launched its funding program to encourage real estate investment, and then newly installed This mechanism for targeted lending to small and medium-sized businesses during the pandemic.

Likewise in April 2020 the European Central Bank introduced Targeted longer-term refinancing operations in which banks that lend new money to the real economy borrow at an interest rate below the main deposit rate. And in October the Bank of Israel introduced its own targeted loan interest rate.

But how can the Fed identify “green investments” if the concept remains so vaguely defined? For starters, it should offer targeted lending for two asset classes already supported: real estate (through security purchases through QE) and automobiles (through lending to a purpose-built instrument that buys auto loans through the Term Asset-Backed Securities Loan Facility). .

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According to the Environmental Protection Agency, residential and commercial properties make up roughly one third around 28% of greenhouse gas emissions in the US and transportation accounts for around 28%. By promoting the greening of these assets, the Fed could have a significant impact on the United States’ contribution to climate change mitigation.

Furthermore, the Fed does not need to reinvent the wheel to determine which properties or cars are considered green. Both Fannie Mae and Freddie Mac offer green credits and green certifications for single and multi-family houses. The Fed and the Federal Housing Finance Agency – Fannie and Freddie’s regulator – could therefore come together to determine the best standards, and the FHFA could then become the green real estate screener.

For cars, the Fed could use the voluntary issuance agreement between the California Air Resources Board and five major automakers (Ford
F -1.34%,
Honda
HMC, + 0.29%,
BMW
BMW, -0.69%,
Volkswagen
Vows, -2.83%,
and Volvo
VOLV.B, + 0.82%
), which requires a 3.7% annual reduction in greenhouse gas emissions from new cars.

Subsidize borrowers, not banks

In addition to adopting clear standards, the Fed must also ensure that banks don’t pocket all of the subsidy. New loans should require a certain minimum percentage of the grant to be passed on to the end user. And for existing loans that meet environmentally friendly requirements, banks should get a re-rating to qualify for the negative interest rate.

Targeted lending using the discount rate is not only an effective measure to combat climate change. it would also strengthen the Fed’s toolkit more broadly. By offering a negative interest rate to certain borrowers while maintaining a positive interest rate on federal funds, the central bank would benefit borrowers and savers at the same time.

This would give the economy a clear boost after an unprecedented decline in activity and an even longer period of struggle for the Fed to meet its inflation mandate. Targeted green lending would allow the Fed to do its job while addressing one of the biggest crises of our time.

Megan Greene, Senior Fellow at Harvard University’s John F. Kennedy School of Government, is a member of the Regenerative Crisis Response Committee.

This comment was published with permission from Project syndicate– –How the Fed could go green faster

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