On the BOJ’s “Fund-Provisioning Measure to Support Efforts on Climate Change”

BOJ’s preliminary outline of its measure to address climate change

Bank of Japan has revealed, at the monetary policy meeting held on 17 July, the preliminary outline of the fund-provisioning measure to support efforts on climate change. According to the preliminary outline, BOJ will provide funds against investments or loans made by the financial institutions that contribute to addressing climate change at an interest rate of zero percent. In the Interest Scheme to Promote Lending, this measure will fall under Category III (interest rate will be zero percent), but an amount equivalent to double the amount outstanding will be added to the Macro Add-on Balances of the financial institutions’ current accounts at the BOJ (interest rate will be zero percent). The preliminary outline was announced in response to the decision made at the monetary policy meeting on 18 June and is expected to be introduced before the end of 2021 and to last until end-March 2031.

Needless to say, climate change is a serious problem facing the inhabitants of this planet: it needs to be address so that we can establish an environmentally sustainable economy and society as soon as possible. Many central banks, including the Bank of England and the European Central Bank, have started to consider introducing monetary policies that take into account the implications of the climate change problem. The decision by the BOJ can be understood as a part of this international trend.

However, from the point of view of the principles guiding economic policies, the BOJ’s fund-provisioning measure to support efforts on climate change (hereafter denoted as M-SECC) requires some clarification. Main points that needs clarification are the following three.

Is it consistent with the BOJ’s objective?

First is about the relationship between M-SECC and the objective of BOJ.

The revised version of the Bank of Japan Act which came into effect in 1998 states that “Currency and monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby contributing to the sound development of the national economy” (Article 2). In order to fulfil the mandate, it also states that “The Bank of Japan’s autonomy regarding currency and monetary control shall be respected” (Article 3). It clearly shows that the BOJ’s objective is to achieve price stability and in exchange it is assured of independence from the government. Bold actions such as the quantitative and qualitative monetary easing (QQE) are the examples of the outcome of such an autonomy.

Such a division of labor between the central bank and the government is perfectly consistent with the principles of economic policies as developed by Jan Tinbergen and Robert Mundell: there is a need for a same number of policy instruments when there is a number of policy targets to achieve, but when this condition is met there is no need for a consultation between the agents responsible for the implementation of the policy instruments if the policy instruments are assigned to the policy objectives to which they have comparative advantage in achiving. It implies that, when monetary policy is considered to be better than fiscal policy in achieving price stability, monetary policy can be left to the sole responsibility of an independent central bank.

The issue here is how we can understand M-SECC in this framework. In the decision made at the monetary policy meeting held on 18 June, it is mentioned that “The Bank considers that supporting the private sector’s efforts on the (climate change) issues from a central bank’s standpoint will contribute to stabilizing the macroeconomy in the long run” (words in parenthesis added by the author). But how does is relate with the objective of the BOJ, namely price stability?

If “stabilizing the macroeconomy in the long run” means “sustained economic growth in the long run”, the question arises whether this falls under the responsibility of the BOJ whose objective is achieving price stability. If it means “smoothing business cycles” that leads to price stability, the question arises as to how addressing climate change contributes to that end. Whichever the case may be, it shows that approaching climate change issue in this way seems to exceed the mandate given to the BOJ.

Of course, it doesn’t mean that BOJ does not have to take climate change concerns into consideration. Climate change is a global issue of urgent need: maximum effort should be made in order to address the issue and BOJ cannot be an outsider. However, if the BOJ is to fulfil the responsibility in the way described above, the consistency with the mandate given to the BOJ needs to be considered and, if necessary, to revise the mandate as well.

In the case of BOE, the chancellor of the Exchequer, in his letter to the Governor of the BOE on March 3, updated the remit for the monetary policy committee “to reflect the government’s economic strategy for achieving strong, sustainable and balanced growth that is also environmentally sustainable and consistent with the transition to a net zero economy”. It means that, in the case of BOE, there was an explicit addition of achieving environmentally sustainable growth as an objective of monetary policy.

As for the ECB, the Governing Council stated, in the decision made on 8 July, that “In addition to the comprehensive incorporation of climate factors in its monetary policy assessments, the Governing Council will adapt the design of its monetary policy operational framework in relation to disclosures, risk assessment, corporate sector asset purchases and the collateral framework.” As part of its efforts, “Comprehensive Action Plan” has been published with a roadmap to incorporate climate change considerations into monetary policy. It has not made any changes to the ECB’s policy objectives but has made explicit explanation as to the relationship between climate change and monetary policy.

Compared to these central banks, the BOJ’s approach to climate change is implicit and unclear. If this kind of approach is pursued, there may be a situation where it will coincide with the policies of the government. Fortunately, in the case of climate change, such a situation has not yet become evident. But if this kind of approach is extended to other areas, there could be a situation where adverse macroeconomic impact may arise because of the conflict with the policies of the government. In order to avoid such a situation, BOJ should implement monetary policy within the mandate given by the Bank of Japan Act. If an important agenda which is beyond its mandate comes up and needs to be addressed, its relationship with the price stability target should be explained explicitly, as were the cases in BOE and ECB.

Is fund-provisioning an effective measure?

Second point that requires clarification is the effectiveness of fund-provisioning measure as a tool to address climate change.

BOJ expects to provide funds to financial institutions that have made investment or loans in their efforts to address climate change. The issue is whether such measure will actually contribute to the promotion of efforts to address climate change.

In the case of BOE, their policy measures are mainly in the area of information disclosure and the progress is published in its report on Climate-Related Financial Disclosure, most recently published on 17 June. With regards monetary policy, it “intends to adjust the way it manages the Corporate Bond Purchase Scheme (CBPS) to take account of the climate impact of issuers of the corporate bonds it holds”.

ECB is planning to develop new macroeconomic models to assess the implications of the climate change and related policies to the economy, and to conduct climate stress tests to assess the risk exposure to climate change. In addition, it is expected to introduce disclosure requirements for eligibility as collateral and asset purchases, and to adjust the framework guiding the allocation of corporate bond purchase.

Compared to these measures that are expected to be implemented by other central banks, the action by the BOJ is a step ahead in the sense that it is going to actually promote corporate efforts to address climate change through easier financing via financial institutions.

It is, however, not clear whether the BOJ’s fund-provisioning measure is going to be effective. Since the corporate sector, especially the large firms, have become less reliant on bank lending, the impact of the increase in availability of low interest funds on firms efforts to address climate change is uncertain.

Moreover, the risk of facing inconsistency with price stability objective of monetary policy needs to be considered. Once the deflation is over and tapering from QQE becomes necessary, what is going to be with the M-SECC? Will it be continued to provide easy financing even at a time of a change in the stance of the monetary policy?

What kind of efforts need to be supported?

The third point to be clarified is about the kind of efforts that need to be supported by M-SECC.

BOJ’s provisional outline leaves the decision on whether the investment or loans are eligible or not to the financial institutions involved and the BOJ keeps out from making decisions. It is because the BOJ “deems it important to give consideration to market neutrality” (monetary policy meeting decision made on 18 June) and not to interfere with market decisions.

However, even when the decision is made by the financial institutions, if it is promoted by its fund-provisioning measure, BOJ is already involved in resource allocation. If that is the case, BOJ needs to have a well-defined criteria about what kind of corporate efforts should be supported.

Furthermore, if it is going to be actively involved in resource allocation, it may be necessary for the BOJ to take into account the impacts of its decesion on aspects that are beyond climate change. More successful the efforts to address climate change are, the more significant their impact on the industrial structure of the economy would be. It would, in turn, change the required skills of the labor force, and have implications on income distribution. If income distribution is as important for economic policy as climate change, selection of corporate efforts to address climate change should be made taking into account their impact on income distribution.

This argument is in line with the suggestion made by Anthony Atkinson in Inequality: What can be done? (Harvard University Press, 2015). In his book, Atkinson states that “public policy can play a significant role in influencing the nature of technological change and hence the future direction of market incomes”. Therefore, it is natural for him to argue that “when making decisions supporting innovation—whether concerned with financing, licensing, regulating, purchasing, or educating—the government should explicitly consider the distributional implications”. If this is true, the argument should also apply to the central banks.

It is worth mentioning that there is a growing interest in the relationship between climate change and income distribution. More specifically, there are studies that finds that, when income inequality widens, climate change worsens as well. For example, Lucas Chance and Thomas Piketty, in their paper “Carbon and inequality: from Kyoto to Paris” (Paris School of Economics, 2015), finds that highest emitters of CO_2 and other Green House Gases are the top income group of high-income economies whereas the lowest emitters are the lowest income groups of low-income economies, but the recent trend is that emission inequality increased within economies. It suggests that policies that reduces income inequality in each country may contribute to improving the climate change situation. In this regard, what may be more interesting is to explore what kind of measures to address climate change will be consistent with reducing income inequality.

Clarification is necessary because addressing climate change is important

We have discussed some of the points that needs to be clarified if the BOJ is going to implement M-SECC. It is worth reiterating at this stage that the discussions were not intended to deny the necessity of the central banks to address the issue of climate change. To the contrary, discussions on these points have been made because it is considered important for the central banks to address the issue in the most effective way.

Before closing, it should be noted that the need to consider impact of measures to address climate change on income distribution is something that applies not only to the central banks but also to the governments.

Back Numbers of Japanese Economy Update (June 2013-August 2018)