Can Central Banks Still Go Green? by Lucrezia Reichlin

As inflation resurfaces, central banks are adopting a more cautious approach to monetary policy. Despite the challenges posed by rising prices, policymakers are exploring the possibility of simultaneously increasing interest rates and implementing targeted green initiatives. The complexity arises from the need to shrink central banks' balance sheets while maintaining a commitment to green monetary policies, which remain crucial in the face of climate change. Central banks hold significant assets, totaling around $40 trillion globally, despite recent declines in their portfolios. While they are not responsible for industrial policy, they possess tools to influence capital allocation through their operations. A review by the Network for Greening the Financial System (NGFS) highlighted that many green measures are primarily aimed at combating climate change rather than managing financial risks. For instance, the Bank of Japan has initiated a program offering 0% interest loans to support investments aligned with the country’s climate objectives. Concerns persist regarding the potential impact of balance sheet reductions on green financing. The US Federal Reserve has chosen to maintain a system of ample reserves, indicating that its liabilities will remain substantial even as inflation stabilizes. This approach allows central banks that adopt a double-materiality framework to align their asset portfolios with national climate and industrial policies. Ultimately, as central banks weigh the benefits of larger versus smaller balance sheets, the imperative to address climate change remains a pressing concern for humanity, underscoring the need for sustainable financial practices.