Cleaning and Leaning: Central Banks, Carbon Bubble and Green QE

A carbon bubble could lead to trillions of dollars’ worth of stranded assets in the world economy and therefore poses a threat to the (long-term) stability of the financial system. Ensuring long-term financial stability through short-term price stability is one of the core tenets of central banking under the New Monetary Consensus (NMC). This raises the question of what central banks can and should do to mitigate the effects of this carbon bubble, as well as which factors determine the depth, width and effectiveness of their intervention under the NMC paradigm. In this paper, we explore these questions in the context of the global energy transition and a classic central banking dilemma. Faced with an asset price bubble, central banks basically face two mutually exclusive options: “leaning against the wind” or “cleaning up after the party”. In the first case, central banks will impose anticipatory measures ex ante to weather the coming storm, e.g. by increasing short-term interest rates. In the latter case, they only react post hoc, albeit with more interventionist measure once the bubble has burst, e.g. through aggressively lowering interest rates or through quantitative easing. We apply this dilemma to three advanced economies’ central banks: the European Central Bank, the Bank of England and the US Federal Reserve. We find that in order to temper long term-financial instability, central banks in the current macroeconomic environment will actually have to impose cleaning measures before the carbon bubble can burst, thus paradoxically speeding up the bursting process and increasing short-term financial instability. We consider the potential of green quantitative easing measures in such a context. We also find that in the current situation, the dogma of central bank independence under the MNC significantly restricts the potential of central banks to help shape the energy transition and mitigate the effects of a growing carbon bubble. We look at ways through which such technocratic restrictions can be overcome by (re)politicising central banks.