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Applying an ESG lens to macroeconomic analysis—a starting place (Part 2)

17 August 2021

Frances Donald, Global Chief Economist & Head of Macro Strategy
 

Central banks and interest-rate outlooks

Growing ESG awareness has also influenced the way we study global central banks and their policy decisions. In fact, we have a more dovish view of the future path of policy rates globally than would have been the case because we recognize that many central banks have begun to incorporate the impact of climate change into the way they assess economic growth and risks, and several of them are in the process of transitioning their mandates—formally and informally—to include more equitable growth.⁴ Indeed, all major central banks have been vocal and deliberate in their recognition of these issues. The Network of Central Banks and Supervisors for Greening the Financial System, which counts most developed-market central banks as members, has commissioned much in-depth research into ESG issues that we believe will inform central bank thinking going forward. In our view, disregarding this clearly discernable shift among policymakers could risk misreading central bank intentions and lead to overly hawkish macro forecasts. 

Central banks and ESG: an evolving landscape


Climate change can increase financial, credit, and liquidity risk

  • All else being equal, growth can be more erratic, with asymmetric downsides
  • A more cautious approach to monetary policy, delayed rate hike cycles

Climate transition can lead to lost economic growth, potentially through supply-and-demand shocks

  • A later, gentler rate hike cycle

Climate change may lead to higher household savings rate, and a higher risk premium may lower the natural rate of interest

  • Central banks have a lower terminal rate to their rate hike cycles
  • Central banks have less policy room to maneuver

Changes in price levels could become more commonplace as climate transition progresses

  • Central banks may become increasingly comfortable with the idea of structurally higher inflation

A growing focus on equitable policies that can benefit households more evenly

  • Central banks may broaden their mandates beyond inflation and pay more attention to the makeup of the labor market, taking into consideration race and gender equality, thereby necessitating a more dovish stance on monetary policy

Source: The Network of Central Banks and Supervisors for Greening the Financial System, Manulife Investment Management, July 1, 2021.

Fiscal spending and the growth calculation 

We’ve previously written about how the COVID-19 outbreak could lead to structurally higher fiscal spending, bigger governments, and a much higher level of government bond issuance. It’s no secret that economists have tried and tested ways to integrate higher government spending into our economic outlooks; however, how governments spend their cash and what they spend it on have important implications for growth.

For context, the amount of government spending that’s been earmarked for green investments among developed economies in the aftermath of the COVID-19 outbreak is unprecedented: Roughly half of the Biden administration’s American Jobs Plan will be related to green initiatives,⁵ while 37% of the EU recovery fund is climate friendly.⁶ Crucially, these initiatives are expected to have a higher multiplier effect relative to non-green infrastructure spending.⁷ Higher levels of green government spending are also likely to reduce overall carbon transition costs and lower risks that might dampen growth as a result of climate change. These are important elements that need to be factored into macroeconomic forecasts.  

There’s one other key aspect to the green spending narrative that’s relevant to global capital markets: surging demand—and, therefore, an expected ensuing rise in supply—for green sovereign bonds.⁸ Several 2021 European green bond auctions were heavily oversubscribed; these are typically longer maturity bonds with higher yields that have the potential to alter the global government bond landscape.⁹ We broadly expect the green sovereign bond market to become an important part of many countries’ debt management strategies and fiscal construct. 

 

4Survey on monetary policy operations and climate change: key lessons for further analyses,” Network of Central Banks and Financial Supervisors for Greening the Financial System, December 2020.

5Does Biden’s American Jobs Plan Stack Up on Climate and Jobs?” World Resources Institute, April 1, 2021.

6Commission welcomes political agreement on Recovery and Resilience Facility,” European Commission, December 18, 2020.

7Building Back Better: How Big Are Green Spending Multipliers?” International Monetary Fund, March 19, 2021.

8Borrowers tap hot ESG demand to sell green bonds at a premium,” Financial Times, April 9, 2021.

9 Bloomberg, as of July 1, 2021.

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