New Research Report from the Centre of Sustainable Finance: “The Price of Hesitation: How the ...

9 September 2021

A new report – “ The Price of Hesitation: How the Climate Crisis Threatens Price Stability and What the ECB Must Do about It ” – published by Greenpeace, the German Institute for Economic Research and the Centre for Sustainable Finance at SOAS, University of London presents for the first time empirical evidence of the impact of natural disasters on inflation in the eurozone, highlighting the challenges facing the ECB to achieve price stability in the era of the climate crisis. The analysis shows that natural disasters lead to increases in headline and core inflation, with price increases being higher for food and beverages. The effects are small but significant. The analysis also shows that there are significant differences between eurozone countries in the way that inflation is affected by natural disasters.

With an escalation of the climate crisis, the frequency and intensity of climate-related hazards will increase in the eurozone. If past data shows that natural events have already had an impact on inflation, this effect can only become stronger as global warming increases, with important ramifications for the ECB’s policies and operations. The ability of the ECB to control inflation may be significantly undermined if the world passes the 1.5 or 2 degrees threshold. Therefore, actions that prevent an increase in global warming have an important role to play in allowing the ECB to achieve its primary objective in the future.

The ECB has taken an important step by announcing its new monetary strategy and climate action plan. While this is a critical first move in the right direction, the report argues that the ECB climate action plan falls short of providing an ambitious agenda consistent with the climate emergency that we are facing.

In this report, the authors set out how the ECB could develop an ambitious agenda that would help it deliver on its primary and secondary mandates. Concretely, they recommend that the ECB and the European System of Central Banks (ESCB) should:

  1. introduce more explicitly climate performance criteria into their monetary policy tools;
  2. align prudential regulation with climate neutrality;
  3. abandon market neutrality as the key principle that guides the design of monetary policy;
  4. incorporate double materiality and macrofinancial feedback loops in macroeconomic modelling and scenario analysis; and
  5. use more ambitious climate-related criteria in their portfolio management.

The authors urge the ECB and the ECSB to be bold in their actions to safeguard macrofinancial stability across the eurozone in the face of climate change. As guardians of the financial system, the ECB and the ECSB need to send clear signals to the financial sector that a net-zero transition of the eurozone economy and the financial system is a key target of its policies, and that monetary and prudential frameworks will be adjusted accordingly.

Yannis Dafermos, a Senior Lecturer in Economics and Senior Fellow at the Centre for Sustainable Finance at SOAS University of London, says: “Although a welcome step, the ECB’s climate action plan fails to provide an ambitious set of measures that are consistent with the climate emergency that we are facing. The ECB roadmap focuses mostly on reducing the exposure of the financial system to climate risks, instead of prioritising the decarbonisation of the euro area financial system. The timeline of the action plan is also inconsistent with the urgency of the climate crisis. In our report, we identify a set of measures that would allow the ECB and the euro area national central banks to step up to one of the most important challenges of our times.”

Alexander Kriwoluzky, Professor of Macroeconomics at Freie Universität Berlin and Head of the Macroeconomic Department at the German Institute for Economic Research, says: “Extreme weather events, such as droughts, have the potential to lead to both an increase or a decrease in prices, for example when the damage from such events brings down demand, inducing in any case price instability. This follows different patterns in different countries of the Eurozone and affects the ECB, as the consecutive divergence in prices will make the task of price stabilisation more difficult. Consequently, the ECB should take climate change seriously and needs to respond to it.”

Mauricio Vargas, financial expert at Greenpeace Germany, said: “This report proves there is no economic stability without ecological stability. A vague ‘soon’ is not good enough, the ECB must start tackling the climate crisis immediately. Their new monetary policy strategy does recognise the overall impact of the climate emergency, but the bank has been too slow to adopt measures to deal with it. If it is serious about its climate commitments, the ECB must stop doing business as usual and immediately take preventive measures such as excluding fossil fuel companies from its portfolio.”

Ulrich Volz, Professor of Economics and Director of the Centre for Sustainable Finance, SOAS University of London says: “As guardian of macroeconomic and financial stability for the eurozone, the ECB needs to do whatever it takes to support the alignment of the financial system with the EU’s net-zero climate goal. There are many levers that it can use, in full compliance with its mandate. The ECB alone certainly cannot fix the problem, but without a proactive role by the ECB, we are not going to be successful in the net-zero transition of the EU’s economy and financial system.”

Jana Wittich, a Researcher at the German Institute for Economic Research, says: “The euro area staggers through another summer of weather disasters in 2021. We prove in our report that these disasters significantly affect and endanger the ECB's price stability mandate. The ECB needs to climate-align its monetary policy strategy and operations now to safeguard the fulfilment of its mandate now and in the future.”

Download the report.