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Bert Scholtens: a green monetary policy can be effective

Date:24 March 2020
Professor Bert Scholtens talks about the effectiveness of a green monetary policy.
Professor Bert Scholtens talks about the effectiveness of a green monetary policy.

Amidst the Corona pandemic, it is easy to forget that there is the climate crisis. Though the effects of the pandemic for the environment are visible from reduced pollution and congestion, the long-term effects are unknown. This contrasts with the climate crisis.

Here, it is perfectly clear that if we don’t take stringent measures, the temperature will increase sharply in the next 80 years and climate systems will be disrupted as will life on Earth. So all hands on deck.

Europe is proposing a EUR 1,000 billion climate adaptation and mitigation program. This makes the EU’s energy transition the largest economic project ever. There is further debate about defending against climate change on the monetary and financial front. The President of the European Central Bank wants to make monetary policy greener and the European Commission has drawn up a "taxonomy" of green financial products.

Bert Scholtens, Professor in Sustainable Banking and Finance, talks about a green monetary policy and whether or not it is effective in battling the climate crisis.

What is the general view on green monetary policy?

“Economists obviously have their opinions ready. My colleague Schuitemaker from the Erasmus University of Rotterdam believes that a green monetary policy is effective, while colleague Eijffinger from University of Tilburg thinks it hobbyism. Non-economists are also outspoken; the Sustainable Finance Lab, a lobby group, even wants to abolish the current monetary and financial policy instruments and system. But little scientific research has been done on it; despite the fact that the problem has been going on for years, the professional group of economists does not go further than the meager recommendation of a CO2 tax.”

How is that possible?

“Realize that the Dutch Banking Act of 1948, the legal framework for the operation of the central bank in the Netherlands, states that the central bank must regulate and stabilize the value of the monetary unit in the way that “… is most useful for the country's prosperity”. At that time, prosperity meant attention to inflation, employment, income distribution, balance of payments, public finances, productivity and productivity growth, and external (unpriced) effects, such as environmental problems. In the 1960s and 1970s, Keynesian economists simplified this to consumption and GDP growth.

The monetarist response was centered on price stability. The Phillips curve (the trade-off between employment and inflation) and the Laffer curve (the ratio of tax rate to tax income) dominated the debate in the world of the economists. The other prosperity aspects were subordinated to GDP growth and inflation.

In the new banking legislation (Bank Act 1998), necessary in connection with monetary and financial integration and the euro, the primacy was placed in the pursuit of price stability and the explicit reference to prosperity disappeared.”

How is this relevant to the climate crisis?

“Luckily, bank presidents go beyond well-paved scripts and often express themselves critically against societal threats to prosperity: they warn against sharp wage increases, excessive government consumption, lagging investments, bubbles in stock or housing markets. These are all things that do not directly relate to price stability, but to the time-honored broad concept of prosperity.

This also applies to the statements of Klaas Knot (the current president of the Dutch Central Bank) about the climate crisis. The climate crisis is highly relevant for prosperity and price stability because the Dutch economy is much more energy intensive than that of other EU countries, while at the same time our energy system is lagging behind in Europe’s energy transition. For example, the role of renewable in the provision of energy is lowest in the Netherlands; all other EU countries generate much more heath and power from renewable resources.

Our financial institutions are also highly exposed to the fossil energy system due to the energy intensity of the Dutch economy. This is reason to investigate how sensitive these institutions are to external effects. Although many economists and lawyers work at De Nederlandsche Bank and financial institutions, only very few physicists and environmentalists can be found at their premises.

It seems relevant and highly desirable that, in addition to the existing chief economist, they also appoint a chief scientist to inform effective and efficient monetary and financial policy. Such policy should do no damage to the environment and should help solve externalities, such as far-reaching climate change and the dramatic loss of biodiversity.”

So the current ideas about green monetary policy do not look at climate change and loss of biodiversity?

“Indeed, I feel it is highly questionable whether the current ideas about a green monetary policy take that into account. These mainly take the form of green quantitative easing, in which the central bank would, for the time being, purchase bond bonds from low-emission companies and not from the emission-intensive industry. Proponents think that the former will get financing more easily and will therefore be able to develop more quickly, while the latter will be the opposite.

This is at least uncertain due to three factors. First, the instrument itself; over time, the bonds will be repurchased or redeemed, which has the opposite effect. In this regard, it is not clear at all what green actually means; the EU’s taxonomy suggests transparency, but the underlying information is unreliable because international value chains and product lifecycles remain unaffected. To be effective, there needs to be a clear relationship with climate and nature; emissions as such are not very informative, as they ignore the complexity of Earth systems and ecosystems and the interaction of organizations’ value chains with these systems.

Second, the bond markets. In Europe, their size and structure is very different from that in the US. In Europe, it is mainly governments who issue bonds. Consequently, the volume of suitable loans is limited. Further, it is only the very large European companies, especially financial institutions, which issue bonds in Europe. In addition, the price effect of green monetary policy seems very limited for the time being, because green bonds are usually only two basis points cheaper than non-green ones.

Third, bonds play a limited role in the development of innovative companies and in the financing of net investments. Bank credit, venture capital and, above all, retained earnings are much more important.

In this regard, it is important to realize that the economy is a system. In it, companies deliver goods and services to each other and are intertwined, sector wise and internationally. For example, windmills are made of steel. Currently, steel production is extremely fossil intensive. But without steel, the potential for offshore wind is inaccessible. Perhaps it makes more sense to change steel production in such a way that it no longer emits greenhouse gases, instead of making it more difficult to produce steel.”

Is that the end of green monetary policy?

“No, help comes from an unexpected source! The current low interest rate means that the future becomes more important: With a high interest rate, the benefits of projects in the future are of little value now. But if the interest rate is zero, all the cash flows of a project are of equal value. Therefore, the effects of climate mitigation and adaptation as well as the preservation and improvement of biodiversity will become much more transparent.

A low interest rate is also justifiable from a moral point of view. After all, by discounting, we implicitly attach less importance to our grandchildren than to ourselves. The traditional assumption is that "technology" will move forward and solve the problems for them. However, this is completely impossible in the case of climate and nature due to irreversibility on the scale of human beings: once Earth systems break down, it might take hundred thousands of years for them to recover. Therefore, low interest rates are helpful for green policy.”

What is further needed?

“Given the scale and urgency of the environmental problems, government intervention is urgently needed. More than a hundred years ago, economic theory already gave the rationale for doing so in welfare theory. And green monetary policy fits within a broad view of the mandate of the central bank.

However, current ideas about green monetary policy are neither effective nor effective. Use of insights from economists who work with non-financial factors and from scientists who have an eye for human actions is necessary to arrive at a responsible policy in which the various prosperity aspects come into their own, the goal is achieved and where the damage is contained.

Low interest rates are extremely relevant from the point of view of climate and nature, and it is therefore desirable for central banks to pursue these. In addition, hard work is also needed in many other areas to protect all life on earth; monetary authorities are not all-powerful.”

For more information, please contact professor Bert Scholtens:



Click here for a Dutch version of this article.