On 21 July, the European Central Bank decided to raise interest rates for the first time since 2011 in a bid to curb inflation. With further rate rises potentially on the horizon, Philipp Heimberger and Lea Steininger argue that climate protection policies could be an unexpected casualty from the central bank’s shift in approach

Heimberger, Philipp

Steininger, Lea

English

LSE Research Online

ECB	interest	rate	hikes	will	damage	climate	protectionpoliciesOn	21	July,	the	European	Central	Bank	decided	to	raise	interest	rates	for	the	first	time	since	2011	in	a	bid	to	curbinflation.	With	further	rate	rises	potentially	on	the	horizon,	Philipp	Heimberger	and	Lea	Steininger	argue	thatclimate	protection	policies	could	be	an	unexpected	casualty	from	the	central	bank’s	shift	in	approach.Widespread	forest	fires,	melting	glaciers,	heat	waves…	the	effects	of	the	climate	crisis	have	hit	large	parts	ofEurope	and	the	world	over	the	summer.	Due	to	the	consequences	of	the	climate	catastrophe,	half	of	humanity	nowlives	in	an	immediate	danger	zone	for	their	own	lives.	Even	in	Europe,	large	regions	could	soon	be	barely	habitable.Investments	of	hundreds	of	billions	of	euros	in	clean	technologies,	environmentally	friendly	energy	supply,	climate-friendly	infrastructure	and	mobility	will	be	required	to	phase	out	fossil	fuels	and	achieve	climate	neutrality.Amid	the	heat	records,	the	European	Central	Bank	decided	on	21	July	to	raise	its	key	interest	rate	by	0.5percentage	points.	Raising	policy	rates	has	the	effect	of	lowering	demand	and	employment	with	the	primary	goal	ofcurbing	inflation:	firms	lower	investments	due	to	higher	financing	costs,	unemployment	goes	up,	and	wages	andincome	levels	decline	with	a	lag.	Notwithstanding	the	intention,	attempting	to	manage	inflation	by	chopping	offdemand	does	not	address	the	supply-side	driven	reasons	for	current	high	price	indices.	Rather,	higher	prices	areimported	due	to	the	impact	of	the	Russian	invasion	of	Ukraine	on	energy	markets,	the	market	power	of	the	oilindustry,	and	the	impact	of	the	war	and	the	Covid-19	pandemic	on	global	supply	chains.ECB	interest	rate	hikes	cannot	increase	the	supply	of	gas	from	Russia,	nor	can	they	open	up	alternative	energysources	or	solve	supply	chain	problems	for	chips	and	semiconductors.	However,	they	will	cause	collateral	damage.In	the	process,	in	addition	to	elevated	unemployment,	which	poses	a	substantive	problem	for	democracy	andsocietal	cohesion	on	its	own,	the	climate	policy	agenda	will	be	particularly	affected.A	climate-friendly	transformation	requires	a	shift	from	technologies	with	high	operating	costs	in	fuels	and	labour	totechnologies	with	high	capital	expenditures.	A	different	business	model	is	thus	required.	For	example,	while	a	gas-fired	power	plant	may	use	its	ongoing	revenues	to	pay	for	new	fuel,	an	offshore	wind	project	uses	its	ongoingrevenues	to	service	debt	incurred	for	capital	expenditures.	The	higher	the	cost	of	capital,	the	less	attractive	anoffshore	wind	farm	is.	Higher	interest	rates	are	therefore	a	problem	for	the	green	transformation.On	the	need	for	public	investmentInvestments	have	to	be	pushed	by	the	state	through	reliable	public	investment	plans	as	well	as	sensibleregulations.	Only	improved	infrastructure	and	planning	security	can	encourage	private	companies	to	expand	intoclimate-friendly	sectors.However,	most	climate	investments	are	not	profitable	in	a	classic	economic	sense.	For	example,	private	companieswill	refrain	from	building	the	infrastructure	for	emission-reducing	public	transport	if	they	will	subsequently	operatethis	infrastructure	without	making	a	profit.	On	top	of	building	infrastructure,	the	public	sector	will	have	to	also	set	thedirection	through	industrial	policy.	This	includes,	for	instance,	planning	and	co-financing	production	structures	formodern	high-speed	trains	to	reduce	air	traffic	in	the	medium	term,	and	actively	promoting	renewable	energy.The	ECB’s	strategyIn	2021,	the	ECB	adapted	its	monetary	policy	strategy	by	promising	to	pay	specific	attention	to	interaction	effectsbetween	its	monetary	policy	and	environmental	and	climate	policies.	In	doing	so,	it	pledged	to	consider	a	number	offactors	that	should	make	it	reluctant	to	hike	interest	rates.	The	ECB’s	primary	mandate	is	price	stability;	itssecondary	mandate	is	to	support	the	EU’s	general	economic	policy.	The	active	promotion	of	more	ambitious	climatepolicies	is	in	fact	a	key	priority	for	achieving	both	mandates.LSE European Politics and Policy (EUROPP) Blog: ECB interest rate hikes will damage climate protection policies Page 1 of 2		Date originally posted: 2022-08-15Permalink: https://blogs.lse.ac.uk/europpblog/2022/08/15/ecb-interest-rate-hikes-will-damage-climate-protection-policies/Blog homepage: https://blogs.lse.ac.uk/europpblog/On	the	one	hand,	further	interest	rate	hikes	in	autumn	could	destabilise	fragmented	Eurozone	sovereign	bondmarkets	yet	again	by	putting	individual	member	states	in	financing	and	liquidity	stress,	thus	forcing	the	ECB	tointervene.	The	new	ECB	bond	purchase	programme	(the	‘Transmission	Protection	Instrument’)	announced	on	21July	is	intended	to	stabilise	capital	markets	for	exactly	this	reason.	However,	it	is	conditional	on	member	statescomplying	with	outdated	EU	fiscal	rules,	which	are	temporarily	suspended.It	is	all	the	more	urgent	therefore	to	quickly	reform	the	EU’s	fiscal	rules	so	that	the	scope	for	climate	policymeasures	is	expanded.	After	all,	euro	member	states	now	live	under	the	constant	risk	of	their	financing	costs	risingmassively	due	to	exclusion	from	the	ECB’s	new	bond-buying	programme	(should	the	fiscal	rules	be	reinstated).Otherwise,	there	will	be	massive	yet	unnecessary	restrictions	on	additional	public	spending	to	tackle	climatechange.Second,	the	climate	crisis	also	directly	affects	price	stability.	After	all,	fossil	fuels	are	the	largest	contributors	to	priceincreases.	Accordingly,	investments	in	clean	energy	will	substantively	strengthen	price	stability.	Renewable	energysectors	are	thus	key.	However,	they	require	large	up-front	investments	and	are	sensitive	to	deteriorating	financingconditions.	If	urgently	needed	investments	were	cancelled	today	due	to	higher	interest	rates,	Europe	would	in	thenear	future	be	even	more	vulnerable	to	the	negative	effects	of	the	climate	crisis.	Only	a	rapid	socio-ecologicaltransformation	can	bring	far-reaching	stability.Investments	in	(price)	sustainabilityThe	ECB	cannot	solve	the	climate	crisis	and	energy	system	issues	on	its	own.	Effective	climate	and	energy	policiesare	in	the	hands	of	democratically	elected	politicians	with	control	over	fiscal	policies.	However,	by	affectinginvestment	costs	and	business	cycle	developments	through	its	actions,	the	central	bank	is	a	major	player	when	itcomes	to	the	direction	and	options	for	climate	and	energy	policy.A	series	of	interest	rate	hikes	would	undermine	important	EU	goals	such	as	energy	security	and	decarbonisation.Moreover,	interest	rate	hikes	cannot	address	the	root	causes	of	the	inflation	we	are	experiencing.	They	work	bythrottling	employment	and	will	thereby	exacerbate	the	current	downturn.	Strong	energy	and	climate	investment	onfavourable	financing	terms	in	the	eurozone	is	central	to	achieving	economic	and	social	stability,	and	price	stability	inparticular.	It	is	up	to	the	ECB	to	promote	these	investments	rather	than	torpedo	them.Note:	This	article	gives	the	views	of	the	authors,	not	the	position	of	EUROPP	–	European	Politics	and	Policy	or	theLondon	School	of	Economics.	Featured	image	credit:	European	Central	Bank	(CC	BY-NC-ND	2.0)LSE European Politics and Policy (EUROPP) Blog: ECB interest rate hikes will damage climate protection policies Page 2 of 2		Date originally posted: 2022-08-15Permalink: https://blogs.lse.ac.uk/europpblog/2022/08/15/ecb-interest-rate-hikes-will-damage-climate-protection-policies/Blog homepage: https://blogs.lse.ac.uk/europpblog/

ECB interest rate hikes will damage climate protection policies

http://eprints.lse.ac.uk/116499/1/europpblog_2022_08_15_ecb_interest_rate_hikes_will_damage_climate.pdf

ECB interest rate hikes will damage climate protection policies

Abstract

Similar works

Full text

Available Versions

LSE Research Online