How climate change is ‘creating a dilemma’ for the world’s central bankers

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As if dealing with short-term economic swings, monitoring inflation and setting interest rates wasn’t enough, central bankers are worrying about climate change.

That isn’t because they want to show that they care, in a bid to shore up their popularity in the midst of fierce debates about monetary policy. It is also because climate change presents clear and immediate challenges for central bankers, in both their monetary policy and financial stabilization roles.

Banks, for example, must begin considering “physical risks to their business models,” Bank of England Gov. Mark Carney noted this week in a speech in Tokyo. That goes from mortgage books exposed to flooding to the impact of severe weather on sovereign risk and the pricing of government bonds.

But the financial industry, whether banks or insurance companies, is also facing risks stemming from the transition to a low-carbon economy: Think of banks’ exposure to carbon-intensive sectors, or loans to owners of diesel-powered vehicles.

Climate-related events could also directly affect monetary policy directly. Drought and cold winters can led to higher food prices. Hurricanes or floods destroy production capacity. Like all supply shocks, noted Benoît Coeuré, a member of the ECB executive board, in a speech last year, weather related events “create a dilemma” for central bankers, since they can hit economic growth and boost inflation at the same time.

That is an even bigger problem for emerging economies, more dependent on commodities, than it is for the western world. In the shorter term, central bankers, in their financial regulator role, must ponder how to price or re-price financial assets in the age of carbon pricing. Or, put another way, what’s an oil major worth it that price is set at a high level?

Carney noted in his speech that much progress has been made by the corporate world in the past few years in terms of disclosure and risk management. It’s safe to assume central bankers will have to keep pushing if they want to be able to manage the big shocks when they arrive.