May 22, 2024 Sarah Bloom Raskin – Duke Law School  When asked by public officials, academics, and journalists, why the Federal Reserve does not incorporate climate risk into its work, Chairman Powell’s go-to answer is that: “Climate policy is not the Federal Reserve’s primary role.” This carefully crafted stock answer is true enough, so far as it goes. But the answer subtly changes the question. While “climate policy” is obviously not the Federal Reserve’s “primary role,” climate change is  the world’s primary financial risk. Therefore, it should be no more possible for the Federal Reserve to disregard climate-related financial risk than for it to disregard pandemic-related risk or war-related risk even though public health policy and defense policy are clearly not the Federal Reserve’s primary functions.    The Chairman’s rhetorical sleight of hand treats climate as a detached or peripheral concern. In a recent appearance at the Federal Reserve Bank of San Francisco, the suggestion was made that the Federal Reserve doing climate policy is as preposterous as the Federal Reserve doing immigration policy. Of course, the Federal Reserve is not the Department of Homeland Security. Neither does it set immigration policy in the sense of setting the number of visas available to foreign students or deploying border patrol agents. However, immigration effects are often a crucial factor in Federal Reserve judgments and considerations about labor supply and demand. Immigration is  both relevant to the Federal Reserve’s statutory employment mandate, and to the overall state of the economy. Federal Reserve economists interpret immigration data, incorporating immigration categories and behaviors into FRB-US, the Federal Reserve’s mega-model of economic performance. They incorporate immigration effects into various labor supply metrics that ultimately play a role in the unemployment rate, labor force participation rate, and job turnover rate. There is a direct and necessary linkage between immigration facts and figures and the macroeconomic variables which the Federal Reserve routinely considers in its work. There are other ways in which particular policy areas currently and appropriately intersect with Federal Reserve mandates. Take for instance, tax policy. Tax settings, which vary by rate, economic sector, implementation, and timing are understood to have economic effects. Certainly, such tax settings are relevant to macroeconomic performance, and ultimately relevant to inflation and employment. Whether or not the effects are significant, the Federal Reserve initially considers them, both in how they manifest in current economic behaviors like spending, investing, and saving, and in how they manifest over time. For example, tax policies drive projections of fiscal debt and deficits and how the economy will behave in the future. They are relevant even though the Federal Reserve is not setting the tax rates, crafting the tax rules, or making recommendations regarding tax enforcement. The Federal Reserve is neither taking on the role of the Internal Revenue Service nor is it taking on the role of Treasury when it considers the effects of tax policy on macroeconomic behaviors. Stated differently, the Federal Reserve considers tax policy even though it doesn’t create it. Another example of analysis relevant to Federal Reserve decisionmaking is demographics: the Federal Reserve needs to ask for data related to  birth rates when it engages in projecting the effects of labor force demographics on labor supply issues, which ultimately will matter in understanding the behavior of both price stability  (which is driven in part by labor costs) and maximum employment (which is driven in part by numbers of working people). Nobody is expecting the Federal Reserve to optimize the reproductive rights of people or weigh in on state laws relevant to abortion; but this is altogether different from the need for the Federal Reserve to understand whether these limits or laws have effects on price stability and maximum employment. The limitation in the Federal Reserve’s rhetoric is that by batting away economic effects no matter where they come from – be it at the border, at the gas pump, or at drought-stricken riverbeds, tremor-prone cities, or water-damaged coastlines –  it undermines its mandates by creating less than complete stories of economic performance and projections.  It ignores what is occurring both in its midst and in its peripheral vision, threatening its ability to credibly and apolitically analyze data, and potentially undermining its ability to ensure price stability and maximize employment. Perhaps something else is afoot with their rhetoric?  In batting away the exogenous climate hits to both the supply side and demand side of the economy, perhaps the American people are being told that there is no effect on US economic performance. Perhaps the Federal Reserve has taken it all into account – including the effects of growing heat and the effects of natural disasters on production, transport, and labor productivity?  The Federal Reserve could be conveying confidence that the effects are not substantial or material to macroeconomic projections. Perhaps monetary policymakers know something that Americans don’t; namely, that the US economy is big enough and resilient enough to absorb unpredictably treacherous and costly climate and environmental harm, that the damage will remain local and predictable and manifest in historic ways in which nature-based systems absorb free riding negative externalities, such as greenhouse gases and continue, without aberration, forever. Even if it is determined the Federal Reserve is taking basic climate impacts into account in its understanding of prices and the ability of people and machines to work in high heat, there’s an additional question. There is that other role that the Federal Reserve insists on maintaining;  namely, macroprudential and microprudential bank supervision. These are significant functions of the Federal Reserve (even after the awkward performance of Federal Reserve supervision in the global financial crisis and, more recently, in the systemically designated failures of the mid-sized Silicon Valley Bank and Signature Bank.) These functions were defended by Ben Bernanke when he was Chairman of the Federal Reserve.  Bank supervision, he argued, was essential to the Federal Reserve being able to perform its role against its dual mandates of price stability and maximum employment.  How this rationale stands up to post-crisis scrutiny (from the perspective of the global financial crisis and the Silicon Valley Bank/Signature Bank crisis) is a separate question.  But for now, bank supervision remains a critical and extensive process engaged in by experienced and expert bank examiners at the Federal Reserve Board and its regional Reserve Banks. Bank supervision is understood as both a macroprudential supervisory matter and as a microprudential supervisory matter. As a macroprudential matter, it is necessary as a tool to enhance financial stability and to achieve the dual mandate. As a microprudential matter, it is a necessary tool to achieve bank safety and soundness. In both cases, it seems there is no escaping responsibility for considering and incorporating climate related financial risk. In the macroprudential case, a relevant question for the Federal Reserve is the extent to which lender financed greenhouse gas emissions promote or reduce financial stability.  This would include incorporating analysis regarding how far along the transition from fossil fuels is; what this transition might mean for the prices of different energy sources – oil, gas, solar, wind, hydro; and what the role is of energy costs on inflationary predictions.  A related macroprudential matter is discerning the methodology used for calculating valuation fluctuations of carbon-based assets on the books of lenders – both bank lenders and wholesale lenders – and discerning whether there are ways in which volatility and lender linkages can trigger contagion. In the microprudential case, a relevant question for the Federal Reserve is how banks are assuring themselves and their shareholders and depositors that they are safe and sound as they grapple with extreme and unpredictable weather-related challenges. With their microprudential hats on, the Federal Reserve needs to ask questions about whether loans might need repricing because of the loss of insurance coverage, whether delinquencies might increase if there are slowdowns in revenues of farmers who are grappling with repeated crop and property damage, or whether mortgages were appropriately underwritten for properties near toxic waste sites or at higher risk of intersecting fire, flooding, or hurricane damage. Bank examiners evaluate risk management, and relevant risk is all encompassing. Whether or not they believe in climate change, and regardless of their personal politics, they have jobs to do regarding risk management. Telling a bank examiner to ignore any risks with political overtones is like telling a cardiologist checking on the condition of the heart to ignore related symptoms in the lungs. In short, the more the Federal Reserve continues to carve out and exclude climate related financial risks from its questions and analysis because it deems them too political, the more in fact the Federal Reserve itself becomes political. The Federal Reserve then has put itself in the position of determining what it deems to be relevant and irrelevant. The Federal Reserve is owed much discretion, but not the ability to determine without question what economic forces and trends it  chooses to delete from its analysis, its models, and hence its macroeconomic policy decisions.[1] Of immediate concern to the Federal Reserve’s inflation mandate should be research findings indicating that heat extremes are enhancing inflationary pressures on a wide range of products.  For example, when research scientists at the Potsdam Institute for Climate Impact Research and the European Central Bank studied more than 27,000 observations of monthly consumer price indices around the world, and then sorted those figures through a fixed-effects regressions model to ascertain how persistently high heat effects inflation, they found that as temperatures increased, prices for food consistently rose as well. Prices stayed high for more than 12 months. Other reports suggest that as heat creates drought-like conditions, water levels in critical transportation routes like the Mississippi River, the Rhine River, and the Panama Canal, have fallen below levels that make it uneconomical for many vessels to operate. The implications for the production, manufacture, and distribution of food and goods around the world are wide-ranging and complex. Particularly noteworthy is that weather events can no longer be always viewed as discrete emergencies rather than as part of a cycle of events where events like heat have interactions with more than one economic outcome; e.g., persistently higher heat might create sea level rise and flooding risk, leading to one set of property losses, but persistently higher heat can also lead to poor health outcomes and labor productivity. This raises the prospect of, if not transient, permanently higher supply costs and potentially higher inflation rates. As insurance companies reprice or withdraw from particular states because of their inability to recover in premiums the claimed costs of damage from heat waves, wildfires, and severe storms, the effects on home inflation are being discerned. In this spirit, the Reserve Bank of India cautioned that ongoing climate change could cause frequent inflationary shocks that might lead the Indian central bank to tighten monetary policy In sum, this Roundtable – with its discerning expert voices in the realm of central bank policy, macroeconomics, and macro and microprudential regulation – reminds us that the legitimacy of the Federal Reserve is undermined when it takes things like the costs and other multi-dimensional effects of weather based events, the trajectory of the energy transition, and the scaling of relevant technologies and alternative energy sources off of its list of potential trends for question, data collection, and analysis. When data and analysis are ignored, because they are deemed to be “climate policy,” lost too is a more robust understanding of what trends mean, if anything, for macroeconomic variables like labor productivity, supply chain resilience, and ultimately price levels, in the realm of high heat. Independence is necessary not for the Federal Reserve to take this analysis off the table, but for it to keep it on the table. The Federal Reserve should be independent precisely so that it can do the job that Congress provided it do when it was created. If the Federal Reserve is to choose what questions it gets to ask not based on empirically observed climate events and data but on political trends, then the independence of the Federal Reserve should be called into question. There is strong evidence that climate change and the impact it is having on the real economy sits squarely within the two Federal Reserve mandates of price stability and employment. The Federal Reserve must do the hard quantitative work regardless of its interpretation of the  direction of the political winds.  Independence means that it asks questions as they relate to the present and the future, and how it is performing against its mandates in light of extreme heat, dynamic climate effects, technological innovation, and the trajectory of the energy transition.   [1] Waiting for Congress to explicitly tell them what might be a relevant trend worthy of analysis is one approach that the Federal Reserve might prefer, but it happens to be one that has proven to be sub-optimal. Indeed, every so often, primarily after a major macroeconomic event or financial crisis, Congress will step in to give the Federal Reserve additional responsibilities. These extra directives were present after the global financial crisis and in the midst of the pandemic. In both crises, the Federal Reserve was given temporary roles. Of recent note and relevance, in the CARES Act, Congress established a Main Street Lending program, an emergency lending facility with concessional rates, and determined that it should be administered by the Federal Reserve. Reports at the time revealed that fossil fuel companies were not otherwise financially solvent main street companies, so they initially did not qualify for these loans. But after pressure from the Independent Petroleum Association of America and eleven senators, mostly from energy producing states, the Federal Reserve relented. This sectoral favoritism made the Federal Reserve appear political, in a way that it declaims when it comes to considering climate-related financial risk.