Written by Ronja Virtanen

The pandemic lockdowns, followed by Russia’s invasion of Ukraine and the ensuing energy crisis have led Europe into an economic downturn. Since March 2022, recession and a spiking inflation rate—one that has floated five times above the European Central Bank’s (ECB) target of 2% during the last months of 2022—have shaken the continent (Trading Economics, 2022; ECB, 2022). Fuelled by inflated energy prices and disruptions in supply from Russia, the looming energy crisis has made it undoubtedly clear that the European Union (EU) must decrease its dependency on Russian fossil fuels, which in 2020 accounted for over 40% of gas imported to the Union (European Council, 2022). With the increased risk of Russia halting completely its gas supply to Europe as a response to the EU’s extensive sanctions against them, the EU must turn towards alternative sources of energy to maintain energy security in the future (World Economic Forum, 2022). 

A solution to end the dependency on Russian fossil fuels and to reach long-term energy security in the EU lies within sustainable energy sources, which can be produced locally within the Union (Hoyer & Kuusvek, 2022). While the European Green Deal has been on the EU’s agenda since 2019—with the goal of reaching climate neutrality by 2050 and cutting emissions by 55% by 2030—accelerating the Union’s green transition has become even more crucial after the Russian invasion.

It remains unclear, however, whether the move towards a low-carbon economy should solely be mitigated by elected governments or whether other stakeholders, such as central banks, should also play a role in this transition. The ECB, for one, has included climate considerations in its policy discussion during recent years (Klooster & Boer, 2022). However, its recent actions of increasing interest rates to combat the spiking inflation have been criticised by economists from the London School of Economics and the Sustainable Finance Lab—among others—for being counterproductive towards the EU’s green transition goals (Caswell, 2022a; Heimberger & Steininger, 2022). Therefore, in light of the recent critique, this article will analyse the ECB’s policy stance regarding the EU’s Green Deal, and discuss the extent to which its monetary policy can play a role in accelerating the energy transition in the EU.

ECB’s monetary policy and climate change

The role of central banks in combating climate change has emerged as a salient topic in academia and policy discussions in recent years. On one hand, public demand for central banks to implement measures to combat climate change has been rapidly increasing. Different parties have been calling for central banks to use monetary policy tools to shape the direction of the economy towards decarbonization, via green asset purchasing programs and other non-conventional monetary policy tools (Matikainen, Campiglio & Zenghelis, 2017). For instance, in September 2022 the World Wide Fund for Nature (WWF) published a call to action signed by over 90 NGOs across the globe—including Greenpeace and the United Nations Environment Programme—, with a list of policy demands for all central banks to integrate climate change considerations into their monetary policy decisions (Caswell, 2022b). Similar demands have been called from within central banks as well: for example, recently an ECB board member (Isabel Schnabel) argued for “reshuffling the portfolio towards greener issuers” (Smith, 2023).

On the other hand, critics argue that central banks should remain neutral over issues that go beyond the scope of their primary objective: price stability (Issing, 2019). Central banks, it is stated, should be seen as independent agents with the specific role of stabilising the economy. Therefore, they should stay within that mandate, while tackling social issues should be left as a responsibility of elected fiscal authorities (Brunnermeier & Landau, 2020). 

As of now, it seems that the ECB has leaned more towards the former stance, as climate considerations have increasingly paved the way for ECB’s policy discussions in recent years. The secondary mandate of the ECB obligates it to support the general economic policies in the Union, including the EU’s climate agenda (ECB, 2021b). 

However, the mandate does not outline the extent to which the ECB should implement said goals in its monetary policy. In the past, the ECB has not taken an active role in combating climate change, but has rather focused solely on its primary mandate of price stability (Klooster & Boer, 2022). However, in 2021 the Bank seemed to change its stance on this, emphasising the importance of environmental protection in its review of the monetary policy strategy (Klooster & Boer, 2022). There, the ECB stresses the impact of climate change on long-term economic imbalances and price stability, and states that it is committed to ‘incorporate climate considerations into its policy framework’ (ECB, 2021a). In order to do so, the ECB introduced a climate action plan, consisting of measures to further guide the EU’s green transition which included, among others, aims to enhance climate risk assessment for assets and the introduction of a climate change criterion to corporate bond purchases (ECB, 2021a). 

This is considered especially important because of the prospect that climate change directly poses to the ECB’s primary mandate of price stability in the long term. Two factors play a role in this risk. First, natural disasters can pose a direct threat to price stability, as the impact of weather-related disasters is expected to be substantial on, particularly, the agricultural sector, destabilising food prices across the globe as a consequence (Olovsson, 2018). According to findings from the Joint Research Centre’s PESETA IV project, the European agricultural sector is expected to experience significant volatility of supply already by 2050 (European Environmental Agency, 2021). Second, and perhaps more crucial for this discussion, sudden policy changes pose a direct threat to price stability. Considering the EU’s climate ambitions for 2030 and 2050, it is inevitable that carbon emission policies will be tightened in the future, which could lead to further supply shocks and the re-pricing of goods and services across carbon-intensive sectors (Schoenmaker, 2021). Therefore, climate change concerns are not considered completely independent of the ECB’s primary mandate, but instead as a prominent risk factor to price stability (ECB, 2021b). Hence, up until recently it seemed that the ECB was increasingly incorporating climate change considerations into its monetary policy, granted that it is mainly justified as a measure to avoid climate change-based shocks to price stability in the long run.

Energy crisis and the ECB’s interest rate hikes

The second half of 2022, characterised by the war in Ukraine, the ensuing energy crisis and soaring inflation in Europe, however, seems to have changed the direction of the ECB’s monetary policy. In response to high inflation rates across the Eurozone, the ECB increased interest rates by a record 75 basis points (bps) in each of its meetings in July and October, followed by a rate hike of 50 bps in its latest meeting in December,  making the ECB’s interest rates the highest since 2009 (Ranasinghe, 2022; Treeck, 2022a). Interest rate raises of similar extent are further expected for the first two meetings of 2023, to be held in February and March (Eglitis & Weber, 2023). According to the ECB’s president Christine Lagarde, the rate increases were unavoidable in order to bring down inflation, which in November 2022 reached an average of 10% in the Eurozone. While decreasing from October’s record-high figure of 10.6%, inflation remains five times above the ECB’s target rate as stated in the introduction, making urgent interest rate hikes necessary to stabilise prices (Trading Economics, 2022; Koranyi, 2022).

These actions, however, have faced criticism from multiple actors, not least for being counterproductive towards the EU’s ambitions in moving towards a green economy. For one, French President Emmanuel Macron and Italian Prime Minister Giorgia Meloni have expressed their discontent with the ECB’s monetary tightening, claiming it to fuel the looming recession by further decreasing demand across the Eurozone (Koranyi, 2022). Moreover, the interest rate hikes have been criticised for their long-term consequences in terms of the EU’s climate goals. The looming recession, combined with record-high interest rates, is expected to slow down investments in sustainable technologies, which are a key factor in the move towards a low-carbon European economy (Heimberger & Steininger, 2022). As green technologies tend to have far higher initial investment costs compared to carbon-intensive technologies, it is likely that they will be prioritised to a lesser extent when industries face the impact of the recession and high interest rates (Bhat, Nair & Purohit, 2022). 

While the ECB has been introducing more climate change considerations into its policy discussion, it is clear that its main focus remains on price stability. This is also backed by Frank Elderson from the ECB’s executive board, who states that “the ECB’s support for EU policies should be without prejudice to the primary objective of price stability” (ECB, 2021b). The current situation with the interest rate hikes, however, poses a dilemma for the ECB, because although the Bank deems them as unavoidable to tackle the roaring inflation, it simultaneously increases the risk of price instability in the long term. As outlined above, climate change poses a direct threat to price stability, and if the process of green transition slows down, as is the risk with the higher interest rates, the menace of future climate-related shocks to the price stability increases (Bhat et al., 2022). 

This is especially important, considering the nature of the current inflation across the Eurozone. Stemming from the lack of energy supply in Europe, caused by the Russian invasion of Ukraine, the root cause of the inflation is supply-side based. While interest rate hikes can affect demand, and thus have the potential to bring down prices, they have no effect on the supply of energy, therefore not solving the issue in the long run (Treeck, 2022b).  

In that sense, the ECB’s recent policies seem to reflect a shift back to the more traditional nature of central banking, dictated by pursuing price stability through short-term interest rate changes (Klooster & Boer, 2022). This is probably the easier solution for the ECB, in terms of maintaining its credibility in serving its primary mandate. However, the cost of that might be increasing long-term price instability, which can be expected if the EU does not accelerate its green transition. Therefore, by attempting to bring down inflation in the short term, the ECB is compromising on the long-term the consequences that higher interest rates pose for the EU’s green transition.

To conclude, although climate considerations have increasingly paved way into the ECB’s policy discussions over recent years, maintaining short-term price stability seems to remain its main concern. Combating climate change is crucial to maintain long-term price stability, but for the time being, the main responsibility to tackle climate change remains in the hands of fiscal authorities. Centering around the European Green Deal, taxation policies, budgetary expenditures and regulatory policies are considered the driving force towards greening the European economy (Attard & Vella, 2022; KPMG, 2021). However, the ability of monetary policy to influence the European green transition should not be overlooked.


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