Green central banking: reorienting finance through a recalibration of monetary policy

This paper examines how monetary policy can be calibrated to promote a greening of finance. The paper reviews existing literature and notes a tendency to either focus narrowly on one policy instrument or provide a menu of options, without much depth or discrimination. This Perspective paper undertakes a theory-based analysis of green monetary policy options using an institutional approach to monetary economics. In so doing, it identifies a policy mix that would reorient finance by structurally modifying the relative incentives of financing green vs dirty assets. More specifically, the proposed green central banking strategy consists in the combined adoption of several, recalibrated monetary policy instruments. The two main ones are core elements of central banks’ collateral policies: making (more) green assets eligible in credit operations with central banks and using so-called ‘haircuts’ to give green assets preferential treatment over dirty assets in those credit operations. Combined, the adoption of the proposed, recalibrated instruments promises to reorder the collateral asset hierarchies that are the backbone of modern financial systems, providing strong financial incentives for enhanced financing of investment in green assets and divestment from dirty assets.Monetary policy can help speed up a greening of the financial sector.Enhanced financing of green assets, as well as divestment from dirty assets, can be incentivized through a range of monetary policy tools.Among the most potent green monetary policy tools is differentiated treatment of green and dirty assets in credit operations, known as collateral policy.Several green monetary policy options can be pursued without compromising other monetary policy objectives (such as price stability).While most central banks currently remain reluctant to engage proactively with such policy tools, the increasing manifestation of climate change is likely to erode such resistance in coming years.