Recent high inflation has put pressure on the Federal Reserve to refocus on its congressionally assigned mandates. This month, Fed Chair Jerome Powell said the agency will “stick to [its] knitting” and not exceed its statutory authority by becoming a “climate policymaker.” Yet all signs point to green policy from the top down.
Powell promised the Fed would adhere to its statutory goals and authorities and not pursue social issues or be influenced by political considerations, particularly on climate policy. The Fed’s climate-related regulations, he said, will be narrowly concerned with financial risk, with no significant distributional effects — that is, they won’t affect banks’ loans or investments in a way that would benefit particular companies or industries
In fact, the Fed is now developing climate-related regulations that almost certainly will influence capital allocation by putting pressure on banks to curtail lending to politically unpopular industries, such as fossil-fuel production, and to expand access to credit for sectors perceived as environmentally friendly.
Powell argued that the Fed should play no role in allocating credit. It would be inappropriate for it “to promote a greener economy or to achieve other climate-based goals.” But Powell has committed the Fed to doing exactly that!
In December 2020, Powell announced that the Fed had formally joined the Network for Greening the Financial System (or NGFS), a coalition whose stated mission is “to mobilize capital for green and low-carbon investments” and “to support the transition toward a sustainable economy.” He claims Fed policy won’t promote the green-energy industry, but he has joined the Fed to a group explicitly dedicated to promoting the green-energy industry.
The Fed is building out its climate-regulatory regime by piloting a “climate stress test” for large US banks. These tests are designed to determine how banks’ capital levels are affected by economic shocks in various hypothetical scenarios. It assumes the shocks will come from two sources: 1) physical damage to property and 2) transition risks such as government policies or changes in business conditions, which might adversely affect the bank’s profitability and capital levels.
Yet, as economist John Cochrane has pointed out, banks are mostly at risk from short-term, unexpected events that could quickly make them illiquid or insolvent. The long-run trends in the climate stress-test scenarios aren’t much of a problem for banks, since they’d have plenty of time to adapt.
That is: There is no reason to think these trends would directly affect banks’ capital levels, nor that the Fed has better information than do the bank themselves about climate-risk exposures.
Plus, the Fed is expanding its climate-regulatory framework by requesting public comment not only on specific procedures to manage climate risk, but also on “governance; policies, procedures, and limits; strategic planning.”
Do climate-related interventions in corporate strategy and governance sound like the Fed is sticking to its mandate? Why shouldn’t we expect this move to have “distributional effects”?
Also at issue: How do we know whether the benefits of such regulations will exceed their costs? They might drive up energy costs while having negligible effects on the climate.
The Fed is exempt from statutory requirements to conduct quantitative analysis of the effects of its policies, but Powell testified that “we already do cost-benefit analysis of everything we do” — when in fact the Fed rarely, if ever, conducts quantitative analysis to ensure that the benefits of its regulations exceed the costs.
I surveyed 27 of the most important proposed capital and liquidity regulations since the 1980s. I found that bank regulators claimed the benefits of their regulations would exceed the costs in only five cases and provided quantitative evidence to support their conclusions in exactly zero cases.
Given the highly speculative nature of climate-risk exposure and the lack of quantitative analysis of other policies, one must presume that a quantitative costs-benefit analysis of such climate regulations is highly unlikely.
So how can we trust Chairman Powell’s assurance that the Fed won’t become a climate policymaker? He can take some specific actions:
- Limit climate stress-testing to plausible but unpredictable events.
- Commit to conducting quantitative cost-benefit analysis before issuing climate-related regulations.
If Powell won’t take those actions, there is no reason to believe his claim that the Fed won’t become a climate policymaker. Congressional action may be needed to ensure that the Fed’s actions stay within its mandate.
Thomas L. Hogan is a senior research faculty member at the American Institute for Economic Research. He was formerly the chief economist for the US Senate Committee on Banking, Housing and Urban Affairs.