Climate Change and Monetary Policy in the Euro Area

Climate change is arguably the greatest challenge of our time and central banks are called to play their part, even if they are not at the forefront of this effort. At the same time, it is not always straightforward to integrate the climate priority with the need to make central bank actions fully compliant with their mandate. Our recent paper seeks to outline some of the issues that need to be addressed when assessing whether the ECB can take action related to climate change in line with its mandate.

In the case of the Eurosystem, the relevant legal provisions are in the Treaty on the Functioning of the European Union (TFEU) and the ESCB/ECB Statute, set out in Protocol (No 4) of the TFEU. The TFEU states that the primary objective of the European System of Central Banks (ESCB) is to maintain price stability. From this perspective, taking into account the implications of climate change and the carbon transition for monetary policy falls within the remit of the primary objective provided it meets certain conditions. If taking climate change considerations into account is necessary to maintain price stability or to safeguard the transmission of monetary policy and thus the singleness and effectiveness of monetary policy, the central bank action would simply fall within the remit of the primary objective. In this case, the ECB would not be directly pursuing environmental objectives, but rather its primary objective of maintaining price stability. The conclusions of the recent review of the ECB monetary policy strategy emphasise the role of climate change for the primary objective.

Of course, monetary policy measures which incorporate climate change considerations to pursue price stability may have indirect effects on the economy or the environment. However, monetary policy measures would not be treated as equivalent to economic or environmental policy measures only because they may have such effects. This is because indirect effects in other policy fields are permitted according to the case law of the Court of Justice of the European Union (CJEU). However, such measures would still need to observe the general principles of EU law, in particular, the principle of proportionality, the principle of an open market economy and the principle of equal treatment.

In addition, the ECB also has been tasked with a so-called secondary objective as the Treaty states that the ECB ‘shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union’. This Article provides that the Union ‘shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment’ (emphasis added). Actions as part of the secondary objective must be without prejudice to the primary objective. Moreover, and importantly, the ECB’s mandate with regard to general economic policies in the Union is only ‘supportive’. This means that the ECB, as an independent institution with a limited mandate, does not bear the primary responsibility for these policies and does not have the power to make policy autonomously. In addition, in the same way as actions taken pursuant to the primary objective, the ECB’s action must observe the EU law principles of proportionality, an open market economy and equal treatment.

An additional relevant legal basis for action can be found in Article 18.1 of the ESCB/ECB Statute, which requires the ECB and the national central banks to operate in such a way as not to incur losses in its monetary policy operations. Physical and transition risks related to climate change may affect the risks to collateral reflected in the ECB’s balance sheet. In this case, action taken by the ECB to mitigate these risks would be within the remit of Article 18.1 of the ESCB/ECB Statute. In the same way, as regards outright purchases, risk management considerations could lead Eurosystem central banks to take similar measures with a view to protecting their balance sheets against potential losses.

In addition to the provisions of the treaties which set out the mandate of the ESCB, the ECB must comply with other treaty provisions which do not establish a legal basis for action, but rather duties with which the ECB must comply in all policies and activities. These include the requirements of Article 11 TFEU, that ‘[e]nvironmental protection requirements must be integrated into the definition and implementation of the Union’s policies and activities, in particular with a view to promoting sustainable development’. The provision is interpreted as establishing a requirement to ‘take account of’ environmental objectives, which are to be integrated into the definition and implementation of the ECB’s tasks.

Consistency with the general principles of EU law has several implications for the ECB and puts some limits to its actions in the area of combatting climate change:

First, any ECB environment-related action needs to respect the principle of proportionality. The CJEU has applied the principle of proportionality to the Eurosystem’s monetary policy, ruling that ECB action may be validly adopted and implemented only insofar as the measures that it entails are proportionate to the objectives of that policy. In other words, ECB monetary policy measures must be suitable for attaining the Eurosystem’s objectives and not go beyond what is necessary to achieve those objectives. The ECB must also comply with procedural requirements, ensuring that its analysis of a proposed measure carefully and impartially examines all the relevant elements of the situation in question, giving an adequate statement of the reasons for its decision.

Second, the principle of institutional balance requires the ECB to exercise its powers with due regard for the powers of the other institutions. That is, the ECB objectives of the ESCB should not be interpreted in a way as to have the effect of transferring to the ECB responsibilities that the Treaties have attributed to other Union institutions.

Third, the principle of equal treatment requires the ECB to ensure that comparable situations are not treated differently, unless such treatment is objectively justified.

Fourth, the ECB ‘shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources’ (Art. 127, TFEU: the ‘open market economy’ principle). This is understood to imply that the Eurosystem should refrain from policy measures which would unduly disrupt the normal functioning of markets or unduly restrict competition. However, this is not an absolute prohibition of ECB interference with market functioning. If required to pursue its primary or secondary objectives, ECB interference with the principle of an open market economy is possible, although more restricted in the case of considerations in pursuit of a secondary objective. In any case, the justification for such interference needs to meet proportionality standards. It should be noted that the ‘open market economy’ principle is a general concept and its application requires complex economic assessments.

Last but not least, the ECB and the national central banks are subject to the prohibition on monetary financing set out in Article 123(1) TFEU. In the area of environmental protection this implies, for example, that they cannot directly finance governments in their effort to carry out ‘green’ investment or any other expenditure in the realm of environmental protection.

Sarah Jane Hlásková Murphy is Lead Legal Counsel in the Directorate-General Legal Services at the ECB.

Livio Stracca is Deputy Director General for International and European Relations at the ECB.

The views expressed belong to the authors only and are not necessarily shared by the European Central Bank. We thank Chiara Zilioli for useful suggestions.