Interview with Focus
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Carla Neuhaus on 17 August and published on 20 August 2021
21 August 2021
Ms Schnabel, do you see the images of the catastrophic floods in Germany or the forest fires in Greece as a sign that the ECB should also do something to counter climate change?
For me, the latest events have confirmed that we are doing the right thing with our new strategy. Only recently we decided to give more consideration to climate protection in our monetary policy. Climate change is the greatest challenge of the 21st century. Unfortunately, we will likely see extreme weather events, such as those we have just experienced, more frequently in future.
But why is that a topic for a central bank?
Climate change has far-reaching effects on economic developments and therefore also on price stability – which is our main task. For example, it exposes the economy to more frequent macroeconomic shocks, which has an impact on growth and inflation.
Critics say that it is up to governments to respond to that, not the ECB…
Of course governments are primarily responsible for taking action. But we as the central bank cannot just stand on the sidelines and do nothing. Our primary objective is to keep prices stable in the euro area. And climate change has large implications for price stability. That is why we are obliged to act in order to fulfil our mandate.
Does climate change push up prices?
That can happen if firms pass on to customers the higher costs they incur by having to become more environmentally friendly or having to adapt their business models. Think of the transition from combustion engines to electromobility or the energy sector’s changeover to renewable energy sources. Added to that is the increasing price of carbon. Food prices may rise, too, if droughts or floods occur more frequently in the future. Nonetheless, it’s not certain that climate change and the transition to a climate-neutral economy lead to higher inflation.
Countervailing effects are also conceivable. For example, the prices for sustainable energy sources may decline if more efficient technologies are developed. It may then become cheaper to generate electricity from renewable energy sources. We will therefore have to see which effects ultimately prevail.
What does that mean for the work of the ECB?
We will need to incorporate climate change considerations into all of our future activities. That starts with us having to redesign the models underlying our forecasts and monetary policy. To do so we need new data that we will have to collect. Climate change will in the future play just as much of a role in banking supervision as in our monetary policy measures, such as our asset purchases.
The ECB is still buying particularly high amounts of bonds from firms with high carbon emissions.
That’s true. When purchasing corporate bonds, we have up to now been guided by the bonds available in the market. That automatically results in us holding a relatively large number of bonds issued by firms with high carbon emissions as part of our portfolio, because such firms usually have considerable financing needs and issue large amounts of bonds. We therefore need to reconsider the principle of market neutrality that we have adhered to up to now. However, it would not make sense to completely exclude climate offenders.
We have to focus on accelerating the transition to a climate-neutral economy. Excluding certain sectors or firms from our asset purchase programme would be counterproductive. In order to lower emissions, firms with high levels of carbon emissions are extremely important because they offer scope for making the most progress. If these firms want to become climate-neutral, they are dependent on favourable financial conditions.
But how do you intend to ensure that the firms actually put the funds raised by issuing bonds towards revamping their business model?
To that end we need to draw up new criteria for selecting bonds. For example, we could in the future buy more bonds from firms that commit to the goals of the Paris climate agreement and thus show that they are willing to adapt their business model.
So is exclusively purchasing green bonds not an option?
No, a purely green asset purchase programme would not be realistic at present in any case. Even though the market is growing rapidly, there would still be far too few green bonds. And let’s not forget: we are already buying almost a quarter of eligible outstanding green bonds.
As a central banker you also need to keep an eye on financial stability. Could the climate crisis become a financial crisis?
Climate change is also an unprecedented risk for the financial system – and it is not limited to one country but has a global effect. This is what we call a systemic risk.
What does that mean in practice?
Around a third of the loans that euro area banks have granted to firms are – to a significant or increasing degree − exposed to climate risks from extreme weather events. That emerged from our macroeconomic stress test, for which we recently evaluated data from 2,000 banks and four million firms. We took into account the effects of natural catastrophes such as floods, forest fires and droughts, which entail huge losses for firms and thus also for banks and insurance companies. In addition, the climate transition measures pose a threat to many firms’ business models.
What conclusion can be drawn from your results?
Above all, they tell us that the earlier we react, the better. We can then still shape the transition to climate neutrality in a way that allows firms to adapt. The longer we wait, the faster and more radically we will have to respond. If the transition comes too late and too fast, many firms could become insolvent and banks could face high loan defaults.
Are these climate risks factored in at all right now? Do rating agencies take them into account when assessing the creditworthiness of firms, for example?
Currently, climate-related risks are presumably not yet appropriately reflected in prices. However, rating agencies are aware of the problem and are working hard to take better account of climate-related risks when assessing credit quality.
What is the situation like for banks?
The ECB as European banking supervisor has already made it very clear to banks that they need to consider climate-related risks. However, initial analyses show that not a single credit institution is fully compliant with the outlined requirements. The progress made by individual banks varies greatly: while some have made significant headway, others still have a long way to go. That needs to change.
Isn’t it in the banks’ best interest to know their risks?
Indeed it is; that is why banks are keen to tackle this issue. As early as next year there will be a comprehensive supervisory review of how banks account for climate-related risks in their balance sheets.
Will climate considerations play a role in banks’ future lending decisions?
Yes, it is safe to assume so. Climate-related risks will weigh more heavily in future decisions whether, for example, a company will be granted a loan and at what terms. Climate may also play a role in real estate lending: it might become easier to borrow money to build an energy-efficient property. This would set incentives, making energy-efficient buildings more attractive. This is why banks play a key role in the green transformation.
To what extent is inflation affected by climate policy measures, for example the introduction of a new carbon tax in Germany?
At the beginning of the year, prices went up following the introduction of the carbon tax in Germany. For now, these are one-off effects. Nevertheless, a gradual increase in carbon prices may well lead to higher inflation rates in the coming years.
In Germany, the inflation rate is already 3.8%. Are you not worried?
We are faced with a very unusual situation and the current high inflation figures are largely due to transitory effects. At the beginning of the pandemic, inflation decreased significantly starting with the first lockdown. This was mostly due to the fall in energy prices and the policy reactions to the crisis – such as the VAT cut in Germany. Now that we are seeing the economy reopen, these effects are reversing. Energy prices are rising, the VAT rate has gone back to its original level, and all of that automatically pushes inflation much higher. In part, this is simply because the high prices of today are set against the very low prices of last year – the inflation rate always shows the change in consumer prices year-on-year.
So the high inflation rate doesn’t bother you?
No, but I do understand why people might be worried. However, if you compare today’s prices with those before the pandemic, it doesn’t look all that dramatic. While we expect inflation to continue rising until the end of this year, especially in Germany, our estimate is that it will fall significantly as of next year.
Does this mean that you see no reason to change your loose monetary policy any time soon?
That’s right, because monetary policy looks at inflation developments in the medium term. And on that horizon, we expect inflation in the euro area to be below our target of two per cent. As surprising as it may sound to some – we are more worried about the inflation rate being too low in the medium term rather than too high. This may change, of course, for example if trade unions were to negotiate higher wages. But appropriate wage adjustments would also be a good sign from our point of view. Increased demand on the back of higher real wages would bring us closer to our inflation target – which we have been falling short of for years – and help us escape the low interest rate environment.
Why exactly did the ECB change its inflation target? It used to be “below, but close to, two per cent”, now the inflation rate is also allowed to moderately exceed it.
The old wording was less clear and had occasionally been misinterpreted. Some had seen it as a ceiling, assuming that while inflation must not exceed it, undershooting it would not be a problem. That is why we made it clear: the target for us is two per cent. And it is symmetric, meaning that too low inflation is considered equally undesirable as too high inflation.
What’s next for the economy? Are we going to see the strong recovery we’re hoping for?
We continue to expect to see a strong recovery. Given the high level of vaccinations, another hard lockdown is unlikely, despite the current rise in incidence rates. The supply-side bottlenecks in some products, such as microchips, are currently the major constraint. This has hit German manufacturers particularly hard. To solve the problem, it would be important for the international community to support developing countries in boosting their vaccination rates in order to successfully contain the virus.
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