Climate Change and the Challenges for Central Banks: Implications for Monetary Policy and Financial Stability

Climate change has emerged as a profound challenge, reshaping the global financial landscape and highlighting the urgency of addressing climate risks. Central banks, traditionally focused on price stability and financial stability, are expanding their mandates to incorporate climate considerations. The systemic risks posed by the climate crisis, including physical damages from extreme weather events and transition risks from the devaluation of carbon-intensive assets, underscore the need for proactive financial strategies. Central banks are leveraging tools such as climate stress testing, green quantitative easing, and climate-adjusted collateral frameworks to address these challenges. However, these measures raise concerns about mandate overreach, market distortions, and the effectiveness of monetary policy in mitigating long-term climate risks. International coordination, spearheaded by initiatives like the Network for Greening the Financial System (NGFS), plays a pivotal role in harmonizing climate-related policies, ensuring global alignment, and fostering resilience. Reliable and standardized climate data remain critical for assessing risks and preventing greenwashing. This chapter explores the evolving role of central banks in managing climate risks, balancing trade-offs, and supporting the transition to a sustainable, low-carbon economy. It emphasizes the interconnectedness of financial systems and the climate crisis, highlighting the imperative for collaborative and innovative solutions to ensure economic and environmental sustainability.