Central Banks and Climate Policy: Unpleasant Trade–Offs? A Principal–Agent Approach

This paper focuses on the trade–offs that central banks would face if they were to start tackling climate change. Disruptive natural events can hamper growth and capital accumulation, thereby affecting price and financial stability – elements for which central banks are responsible. Yet, the array of instruments they could use to mitigate climate–related risks overlap with those already used in relation to their monetary and macroprudential mandates. By leveraging a principal–agent setting, we consider the conditions under which the central bank architecture would be fit to take on this objective without jeopardising the attainment of central banks’ core mandates. We also examine the corresponding effects in terms of climate risks. Our results show that central banks’ effectiveness in this regard depends on the degree of their independence from governments’ climate preferences and on their ability to calibrate their “green” easing, either monetary and/or regulatory, on the realised level of abatement and emissions.