The Fed’s Climate Hypocrisy

W hy is the Federal Reserve, the central bank of the United States, involved with climate policy? In congressional testimony this March, Fed chairman Jerome Powell faced questions on the agency’s climate agenda, but his responses were not consistent with the Fed’s own policies.

For example, Powell said (and has often repeated) that the Fed will not be a “climate policy-maker.” It would be inappropriate, he said, for the agency to use its tools “to promote a greener economy or to achieve other climate-based goals” and, furthermore, that its policies will not have distributional effects that disproportionately harm particular companies or industries.

None of these claims are true. The Fed’s proposed climate regulatory framework is more focused on deterring fossil-fuel production than on minimizing bank risk. This green-energy agenda will clearly have distributional effects, punishing some groups while rewarding others.

The Fed’s deception isn’t even subtle. Indeed, the Fed is an active member of the Network for Greening the Financial System (NGFS), an international collective of central banks and financial regulatory agencies that has the explicit purpose of mobilizing “mainstream finance to support the transition toward a sustainable economy,” which includes directing capital to “green and low carbon investments”

This raises a simple question: Is the Fed committed to promoting green energy, as the NGFS’s mission states, or is it committed to not promoting green energy, as Chairman Powell claims?

Those things cannot both be true. Powell should either admit that the Fed is promoting the green-energy industry, or he should end the Fed’s commitment to the NFGS.

The latter would be better. The Fed’s only responsibility related to climate is to ensure that banks maintain safe and sound risk-management practices. It is unclear, however, how many of the risks cited by the Fed are related to bank safety or soundness. The Fed’s proposal does not explain, for example, how environmental changes such as ocean acidification are expected to affect banks’ capital and liquidity.

While it is true that events such as fires and floods can affect bank loans or investment values, banks already hedge these risks using insurance and ordinary risk-management practices. If the Fed believes its current regulations are inadequate, then those rules should be revised. Otherwise, the Fed should focus on the actual risks, not their relationship to the climate.

Bank regulation is intended to address sudden collapses in bank capital or liquidity. In contrast, the climate-related risks cited by the Fed are long-term trends that will emerge over decades. As John Cochrane has discussed, banks will have ample time to adapt and mitigate such risks, which are fundamentally different from short-term risks to the financial system.

The Fed’s proposal warns of “transition risks” from policy changes that might occur during the “transition to a lower carbon economy.” Banks may be pressured, for example, to refrain from lending to oil companies simply to avoid risks that might be posed by future regulations on oil production. By this standard, no actual risk need be apparent, and no legislation need be passed by Congress. Merely the threat of future regulation is enough to restrict lending to the fossil-fuel industry.

Powell says the effects of Fed policy will be neutral across sectors and will not have “significant distributional and other effects on companies, industries, regions, and nations.” It is clear, however, that the Fed’s policies will have disproportionately negative effects on American energy companies. Similar to Operation Chokepoint — the Obama-era program in which regulators discouraged banks from lending to gun companies, payday lenders, and other politically unpopular industries — banks today may be pressured by the Fed not to lend to oil and fossil-fuel companies.

In sum, the Fed has an important duty to monitor and help mitigate risk in the banking system. Its activist climate policies, however, not only fail to help minimize financial risk, but threaten the Fed’s status as an independent central bank. If Powell truly wants the Fed not to be a climate policy-maker, he must abandon these climate initiatives.