July 17, 2024 Jens van ‘t Klooster and Eric Monnet  In a recent speech on Europe at the Sorbonne, the French President Emmanuel Macron called for a debate on the objectives of the European Central Bank (ECB), urging for them to be revised to take into account ” at least a growth goal and, if not a decarbonization goal, in any case a climate goal for our economies”. That is commendable, as these objectives are crucial for effective economic policies to deal with climate change. But this proposal expects too much from central bank mandates, which unavoidably leave many questions open. It also rests on the idea that central banks are mere technocratic institutions and that only the definition of their legal mandate is a political matter. This is not a sound starting point to think about current possibilities for central bank climate actions. In this blog we discuss the limits of democratization through central bank mandates. We also point towards some of our recent proposals to strengthen the European Parliament’s role, without the need to change the European treaties, and how they could be extended to other countries, including the United States.

The illusion of narrow mandates

As Monica DiLeo emphasized in her contribution to the roundtable, central bank mandates are vague. This is also something that we think is crucial for understanding the challenge central banks pose to democracy today, and a key starting point for a recent book by one of us. A term such as “price stability” or “the stability of the currency” appears in many, often with an equally vague set of further objectives. The Bank of Japan, for example, aims at “achieving price stability, thereby contributing to the sound development of the national economy”, which it should do making sure that “the basic stance of the government’s economic policy shall be mutually compatible.” (Bank of Japan Act of June 18, 1997, Article 2 and 5). The Federal Reserve Bank of Australia pursues “price stability, full employment, and the economic prosperity and welfare of the Australian people.“ In the case of the ECB, the European treaties assign to it a primary mandate of price stability and a “secondary mandate”, that calls for the ECB to “support the general economic policies in the EU”. These objectives explicitly include “the protection and improvement of the quality of the environment”. The coveted environmental objective is thus already present, even if competes with other laudable goals such as peace, freedom and “rich cultural and linguistic diversity”. Whether and how central banks address climate change is for now in their own hands. Nothing stops central banks from adopting a definition of price stability that favours a rapid energy transition. Volatile energy prices remain the major driver of short-term shocks to the price level. Moreover, a 3-degree world will not have a stable 2% growth of consumer prices. Raising rates to fight inflation is self-defeating if since high rates disproportionately disadvantage clean energy investments. We have argued elsewhere for that climate change creates a new dilemma for central banks: monetary policy that seeks to bring down inflation in the short term by raising interest rates and restricting investments in climate mitigation makes the global economy more vulnerable to future climate- and biodiversity-related economic shocks, including adverse shocks to price stability. A solution to this dilemma is that the central bank applies a lower interest rate when refinancing environmentally sustainable project, as many European central banks did until the late 1990s for the refinancing of export credit (then deemed a priority to avoid balance of payments troubles). But central banks can also decide to do nothing. Vague mandates combined with a high level of central bank independence can create unaccountable technocratic agency. Conservative critics typically want to maintain independence, while restricting the ability to change the interpretation of the mandate, in particular if that interpretation is colored in green. This is a mistake on many levels. The generality of central bank law, which has always prevailed in the past, is not a design flaw but is meant to allow central banks to quickly respond to new and unexpected situations. More fundamentally, if central bankers did not regularly reconsider their policies, they would quickly get stuck in outdated and dysfunctional approaches. The Great Financial Crisis of 2007 and 2008 illustrates the profound dangers of insufficient technocratic agency: globally active banks were allowed to build up ever more risk without supervisory intervention, until a crash was all but unavoidable. To ignore climate change today would be an even bigger mistake. These reflections make clear that there is no such thing as a narrow mandate; central banks are empowered to act on a wide range of considerations, and merely choosing not to do so does not make the mandate shrink. In short, central banks could act decisively toward decarbonization without a change of their mandate. However, for proponents of green central banking, a pressing democratic issue persists. . The concern is not that central banks revise the interpretation of their mandate, but that they do so without sufficient checks and balances. Legislatures can (of course) change mandates, but these projects tend to be woefully unsuccessful when pursued against the will of central banks. Externally imposed mandates are often scuppered by the central bank itself; we can think here of the 1972 attempt by the Willy Brandt government to introduce shared Treasury control over the use of two new instruments. In the EU, Treaty change involves an intergovernmental conference, referendums, queens, kings, dukes, and dozens of other political bodies and obstacles. And when successful, new mandates can be ignored; think of the decision to give the Fed a full employment objective, just four years before the Fed’s 1981 Volcker shock brought US unemployment to 11%. If new mandates are no panacea, then must we embrace green technocracy? Here, we think the decisive questions pertain to who gets to be involved in the interpretation of central bank mandates.

Central banks and democratic principles

Central bank independence typically entails that central bankers are free to interpret their own mandate. They not only possess the formal legal authority to do so, but also the required expertise. While coordination is widespread, it typically takes the form of “independent policy coordination”, the central bank itself decides what broader economic policy objectives to pursue and which to disregard. Existing mechanisms of democratic oversight are typically weak. Politicians lack incentives to acquire knowledge about an institution over which they have no say. The ECB’s accountability relationship with the European Parliament (EP) has remained unchanged since early 2000s. Back then, the central bank constrained itself to pursuing one narrow objective, 2% inflation over the medium term, using a single instrument, short-term money market rates. Since then, the ECB’s role has changed dramatically, encompassing a wide range of objectives and tasks, supporting the EU’s climate policy being just one of them. Although additional channels of ‘dialogue’ have been introduced, the ECB’s approach to Monetary Dialogues remains narrowly aligned with the democratic accountability provisions of the Maastricht Treaty. It is perhaps the main element of continuity in the interpretation of the ECB’s mandate, which has otherwise evolved considerably since the 1990s. A second way in which independent policy coordination is insufficiently democratic is that central banks present their interpretation of the legal mandate as the only correct one, thereby not properly explaining the trade-offs they implicitly or explicitly make. Before 2020, the ECB simply ignored its secondary mandate; it is referred to in only 11 speeches between 1998 and 2019. It also brushed off concerns over its support for fossil fuel companies with reference to a supposed principle of “market neutrality”, which has, at best, a shallow basis in its legal mandate. While the 2021 Strategy Review led the ECB to take a much more ambitious approach, this re-interpretation again largely side-stepped any dialogue with the other political bodies of the EU. The ECB effectively assigned itself a climate mandate. These considerations have led us to propose ways to widen the political bodies involved in interpreting the mandate and designing monetary policy. A minimalist approach  would build on the existing accountability practices. In Europe, the European Parliament should ask the ECB to provide a detailed impact assessment of new programs, comparing design parameters with available alternatives. Moving beyond mere accountability, it would also be welcome to introduce a procedure involving the Council and the European Parliament to specify and prioritize the ECB’s secondary objectives. This should take the form of proposals rather than instructions, in order to preserve independence; the text of the secondary mandate itself would remain the source of legal bindingness. The Bank of England already has a similar dialogue with the Treasury via so-called remit letters. A more ambitious reform would create a body to collect diverse opinions from civil society on the objectives and consequences of the central bank actions, and to provide independent expertise to consider alternative economic policy scenarios and interpretations to those proposed by the central bank. For Europe, we have previously formulated proposals to create a European Credit Council that could not only provide a forum for debate on what on what fulfilling the already existing objective of environmental protection mean for the ECB, but would also enable the Parliament to consider the coherence between ECB policy and other EU financial policies primarily concerned by the climate issue, such as the European Investment Bank or the European Structural and Investment Funds.  This council would not be a decision-making body, and it would not be partisan. As we have shown, it is compatible with central bank independence. Yet it would fundamentally change the balance of power between the central bank and the representatives of the people in three ways: It would i) collect and express a variety of opinions about CB actions and their consequences; ii) strengthen the parliamentary oversight of the central bank through a stronger balance of expertise on monetary and financial issues; iii) increase coordination between the monetary policy of the central bank and other credit policies implemented by other state institutions. Indeed, one of the imperatives of a democratic state is to make economic interventionism fully visible, and to assess its scope and extent. We still lack institutions that map the interactions between monetary and credit policy, and discuss their potential, tensions and consequences. Although originally formulated in the European context, a credit council can be implemented in all democracies where the parliament oversights the central banks and the relationships between the central bank and the parliament currently suffer from a imbalance of power. A recent book by one of us as well as an article by John Feldman discuss how to create such an institution in the United States, in light of other recent proposals to democratize central banking in this country. Democratic values should not be a warrant for passive central bankers and supervisors. As powerful policymakers, they are the primary conduit via which public policy makes its stamp on financial markets.  The conservative vision of a central bank trapped in a decades old mandate is not fit for the 21^st century. Dialogue and effective policy coordination can go together with technocratic agency. This is the way to enable democratic and green central banking today.   Éric Monnet recently published Balance of Power: Central Banks and the Fate of Democracies  (Chicago University Press)