“Green Swan” Financial Risk

Ms. Lagarde, President of the European Central Bank(ECB), said that it is a “critical mission” for the ECB to address climate change risks. She took a step further, adopting more positive stance as the central bank governor, whose main task is to secure the stability of price and the financial system.

Fulfilling this “critical mission”, “green quantitative easing” can be one of the policy instruments; it engages in purchasing green bonds to invest in the environmental field. More relevant, however, are prudential policies to keep the financial system sound.

“Black Swan” is a financial crisis that cannot be predicted from ordinary experience. “Green Swan” is the alarm for the financial crisis caused by climate change. In January this year, the Bank for International Settlements (BIS) published a “Green Swan” report; it pointed out that strong restrictions on carbon dioxide (CO2) emissions (carbon budget) to combat global warming could create unusable fossil fuels, incurring $ 18 trillion stranded assets. It far exceeds the subprime loan ($1.3 trillion) that triggered the last global financial crisis.

The stability of the global environmental system is the basis of price and financial system stability. Private banks need to raise their capital ratios by 4%, according to a stress test on climate change risks conducted by the Dutch central bank. The former Bank of England governor Mervyn King argued that in the next financial crisis, the central bank should become “a pawnbroker for all the seasons”, which undertakes any nonperforming assets. In the event of fire sales of stranded assets, the central bank would be the “lender of last resort to those assets.”

The top priority in responding to the current corona shock is a prompt public health policy to prevent the spread of the disease coupled with its needed fiscal measures and the development of effective vaccines against the new coronavirus. The task of monetary policy is to prevent the spread of the corona crisis to the debt crisis (“Black Swan”) in advance.

On the other hand, the top priority for overcoming climate change is to curb greenhouse gas emissions. In addition to the technology development and regulations, the use of market mechanism is effective in controlling emissions. It is desirable to introduce a universal and single pricing (carbon pricing) on the negative externalities of greenhouse gas emissions. The simplest measure is the carbon tax. Japan is equipped with a global warming tax of 289 yen per tonne of CO2 emissions.

The Japanese government has set a goal of 80% reduction in CO2 emissions by 2050 based on the fiscal year 2013. According to the long-term forecast of the Japan Center for Economic Research, 60% reduction can be achieved by successful digital transformation of the economy. In order to achieve the remaining 20%, it is required to impose a carbon tax of 10,000 yen.

When the “Green Swan” emerges on financial markets, it may be too late to restore the global environmental system. One company launched “negative emissions project” which captures all the CO2 emitted since its inception from the air. Since ancient times plants have taken in CO2 from the air with the help of solar power and water. This technology corresponds to a vaccine development against the new coronavirus. If the human being can restore the circular economy which the Earth had formed, “Green Swan” will immediately disappear.

(The english translation of the article was published in the Nikkei morning edition 2020/03/13.)