In Europe, the COVID-19 pandemic and the energy crisis have both weighed heavily on national Budgets. As the issue of energy transition becomes more pressing, can - and should - the European Central Bank (ECB) support governments?
The energy transition will require not only a huge transformation of the productive system, of its infrastructure, its buildings… It will also require a historic change in consumption patterns, particularly in the most advanced economies.
To achieve the zero net greenhouse gas (GHG) objective by 2050, we must drastically reduce our dependence on fossil fuels (coal, oil and gas), which currently account for 80% of energy consumption worldwide¹. This will require a huge development in the use of low-carbon sources of electricity, improving our energy storage capacity (batteries, green hydrogen) and an unprecedented energy efficiency drive in all sectors.
What will it take?
The investments needed for this transformation are colossal. The International Energy Agency (IEA) estimates that, to meet the Paris Agreement objectives, they should triple globally from current levels to about between USD 4 trillion to USD 5 trillion a year by 2030².
The demanding scale of these investment requirements however pales in comparison to what the world is set to lose should it chose inaction. According to a recent survey of economists, a "business as usual" scenario would result in an annual loss of 2.4% of GDP in 2030... and 10% in 2050³. This is four times as much as the investments required to avert a global disaster.
The role of governments and legislators is central. Not only are they responsible for the design and implementation of new environmental policies, but they also possess the most appropriate tools to meet the challenge.
However, in recent years, calls for central banks to play a more active role in supporting the energy transition have increased, particularly in Europe. After all, during the COVID-19 pandemic, European governments and the European Central Bank (ECB) succeeded in preventing an economic collapse by working together. Couldn’t this joint effort be a first step towards closer cooperation in the future? So, suggestions are being made for the two to become almost as close as in a marriage of convenience, a concept made the butt of jokes in the 400-year old French ballet “Mariage forcé” by Jean-Baptiste Lully.
When, in March 2020, European governments used their budgets to support their economies, the ECB launched in their wake a major securities purchase programme (Pandemic Emergency Purchasing Programme or PEPP). This has had the effect of pushing long-term interest rates to even lower levels, easing governments’ debt burden while helping to support demand.
Central Banks: All Hands On Deck?
So why couldn’t the ECB create a new programme to support public policies and facilitate the financing of the energy transition? Don’t the EU treaties confer on the ECB, in addition to its price stability objective, the task to “support general economic policy in the Union, with a view to contributing to the achievement of the objectives of the Union⁴ ”? And isn’t the energy transition clearly one of the Union's objectives?
The answers are not as straightforward as they may first seem. EU Treaties are prohibited from allowing monetary financing of public deficits. Unless this rule is changed, direct financing of the energy transition is not possible either by the ECB or Member States’ national central banks.
That said, couldn't monetary policy nevertheless help governments by keeping their financing costs low? However here again Treaties condition ECB’s action. The actions of the ECB should indeed aim to support EU policies “without prejudice to its primary objective” (of price stability).
In 2020, the cooperation between fiscal and monetary policies was “natural”, as the central bank acted to dispel the fear of a deflationary spiral. However, when the economy is near full employment, this cooperation becomes less obvious. To fulfil its primary objective of ensuring price stability, the ECB has little choice today. Faced with high inflation and an unemployment rate at its lowest level since the creation of the euro, it must raise its key interest rates. Monetary history shows that it becomes very expensive to regain control of inflation if inflation expectations have been allowed to spiral out of control.
So…. are we stuck?
Be it the climate emergency or any other crisis, placing the central bank at the "service" of fiscal policy would not only require an amendment of the Treaty on the Functioning of the European Union (TFEU). Making an exception for the energy transition would also create a dangerous precedent: if we can weaponise monetary policy for this project, why not also for education or the improvement of social infrastructure?
In addition, making such “exceptions” would, effectively, divert monetary policy from its primary role as a tool for managing the business cycle. Monetary policy is not the right instrument for "financing" permanent spending programmes. Neither are government deficits, which should be reduced when the economy is close to full employment.
Energy transition requires a much more structural action plan that only governments can enact. Of course, the ECB should not ignore climate change and the many risks it poses, not only to price stability but also to financial stability. On their part, central banks must continue “greening” their monetary policy operations and encourage companies and financial institutions to be more transparent about their carbon emissions. However, a view that that the energy transition can be achieved by pushing central banks to buy government debt is likely to prove deceptive.
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¹ Hannah Ritchie, Max Roser and Pablo Rosado (2022) - "Energy". Published online at OurWorldInData.org. Retrieved from: 'https://ourworldindata.org/energy' [Online Resource]
² https://www.iea.org/reports/net-zero-by-2050 Net Zero by 2050 - A Roadmap for the Global Energy Sector (windows.net)
Page 81 “The NZE expands annual investment in energy from just over USD 2 trillion globally on average over the last five years to almost USD 5 trillion by 2030 and to USD 4.5 trillion by 2050”.
⁴ Treaty on European Union and the Treaty on the Functioning of the European Union article 127 EUR-Lex - - EN (europa.eu).
