A Greener Policy for Central Banks Bond Purchasing ProgramsIGIER VISITING STUDENT TANVI GOYAL REPORTS ON THE SEMINAR BY MONIKA PIAZZESI (STANFORD UNIVERSITY): HEAVY BOND ISSUERS ARE LIKELY TO BE HEAVY EMITTERS
Climate change is an irreversible and urgent crisis that has motivated central banks to re-evaluate aspects of their operations and preparedness from this lens. One such aspect that European Central Bank (ECB) highlighted in their climate road map was corporate bond purchases in the conduct of their monetary policy. To avoid distorting markets or making arbitrary choices, they try to buy a “neutral portfolio”, namely a portfolio that buys each firm’s bond in proportion to its outstanding market share. But is this really neutral from the climate lens? In the IGIER seminar of Nov 25th, Prof. Monika Piazzesi from Stanford University presented a joint paper with Prof. Martin Schneider and Dr. Melina Papoutsi, arguing that this is not the case. In particular, Prof. Piazzesi uncovered that ECB’s corporate bond purchase program is indeed “brown” and overweighs polluting sectors as compared to the importance of these sectors in the economy as a whole.
The worry, Prof. Piazzesi argued, is that this bias through bond purchases towards the high emissions sectors will reduce their cost of borrowing compared to other sectors, promoting their polluting activities. Two questions then follow. First, why does a bias occur despite attempting to maintain a “neutral portfolio”? Second, can the central banks solve the bias and environmental social welfare problem? Perhaps it is the government, not the central bank, that has the solution through taxes and subsidies.
To address the first question – it was argued that, in general, market neutral bond market purchases don’t exit. When the central banks use funding from safe debt to support purchases of comparatively risky securities - bonds, they favor firms that are riskier and more bond-levered. Instead, when one investigates the climate specific aspect of non-neutrality, we see that that the firms that are more fixed capital heavy (and that subsequently emit more pollutants) tend to issue relatively more bonds, for example in the energy and manufacturing sectors. On the other hand, the ‘greener’ firms, in say the service sector, have relatively higher funding from equity and loans.
On the second question about the scope of intervention, Prof. Piazzesi postulated through the study’s model that if the government did have adequate carbon tax levied, then the optimal policy solution to environmental social welfare problem would be found without central banks having to factor in climate externalities. But given it is not the case in reality, a green monetary policy will help improve welfare. With respect to what central banks can do, for the general non-neutrality concerns the study suggests to change the current criteria of measuring market neutrality. Moving from purchasing corporate bonds in proportion of market outstanding, the study suggests purchasing bonds keeping the relative cost of capital unchanged across firms. Without this shift, contrary to the central banks’ aims, there will be a distortion in market portfolio. As a more direct mechanism, central banks can consider the climate risk factor in designing their corporate bond portfolio, and also increase dirty firms’ cost of capital by making them ineligible for purchases.
Further, going beyond the study of corporate bond purchases, the discussion in the seminar shifted to alternative within unconventional monetary policies of asset purchases. As mentioned before, greener sectors tend to depend more on equity and loans, hence it was discussed that purchasing equity and creating venture capital setups could be possible avenues to consider for the central banks. And, further broadening the scope, macro prudential policies can be a possible avenue; as it is possible that the private banks are more equipped in assessing the risk of innovative and young firms in the green sector than the central banks. More concretely, as seen in the case of Bank of Japan, it can be made cheaper for banks to give loans to green firms.
To conclude, on 8th July, 2021, ECB had presented a climate road map which included reassessment of market neutrality and efficiency concepts. Specifically, to assess the potential biases and make proposals for alternative benchmarks (especially for corporate bond purchases). In this backdrop, the findings presented by Prof. Piazzesi are critical and the discussion provided interesting scopes of future study. The key takeaway would be to have a higher awareness on how true the idea of a “neutral portfolio” is and how crucial are the central bank policies, in the contemporary scenario, for the market of green firms.
by Tanvi Goyal