Central banks are at risk of over-promising on how they can respond to the challenges posed by climate change, a Nobel economics laureate whose work questions how well economic models cope with uncertainty has warned.
Professor Lars Peter Hansen, an economist at the University of Chicago, raised particular concerns about moves by major central banks around the world to stress-test how exposed commercial banks are to climate risk.
A joint winner of the 2013 Nobel for work exploring the limits of economists’ efforts to understand risk and its implications, Hansen has argued that policymakers tend to play down doubts they privately harbor about their knowledge gaps.
While acknowledging that fiscal policy such as carbon taxes or subsidies for green technology can have an impact in lowering emissions, Hansen said the case was unproven for central bank tools ranging from monetary policy to bank supervision.
“Their toolkit is relatively limited and I do worry about them projecting the ability to do stuff … that they don’t have the power to do successfully,” Hansen said in a phone interview.
He described climate-focused stress tests as “a superficial attempt to address a very challenging problem,” doubting they could pinpoint exposure to climate risk given the lack of past experience of it and the fact that such exposure will play out across a range of variables over as long as 30 years.
“We need to have more commonality in how we are thinking about the problem if we are going to have any type of sensible regulation … on stress tests they’ve really jumped the gun,” he told Reuters.
Among leading central banks, the Bank of England in June launched its first green stress tests of top banks and insurers to assess how exposed they are to climate risks.
The European Central Bank will conduct stress tests of the climate risk exposure of banks in the euro area next year. The U.S. Federal Reserve has for now asked lenders to explain how they mitigate such risks, but Fed Chair Jerome Powell has said he would be open to some form of stress test in future.
Hansen was equally skeptical about whether central banks should tilt their huge portfolios towards green assets such as low-emission businesses, saying he doubted whether they had the in-house expertise or mandate to make such investments.
Central banks should work to ensure funding is available for promising technologies that might come down the road, including ones that contribute to long-term decarbonisation goals, he said. But he added they do not have the expertise to assess which specific investments are the most promising.
Part of the push for central banks to develop their climate policies might come from a rising sense of frustration within society that governments have so far failed to combat rising carbon emissions, he suggested.
But he said there were risks for central banks in straying beyond their mandates into the arena of elected officials.
“Many central banks have done a good job overall in establishing reputations for being reliable relative to fiscal authorities. They may have more to lose in terms of their current reputations,” Hansen said.