The Times They Are A' Changin'

Talk about charter creep. This is more like a charter leap.

As we know well by now, the Federal Reserve’s famous “dual mandate” is to promote price stability and maximum sustainable employment. But as we also know, the Fed really has a third mandate, maintaining moderate long-term interest rates (don’t ask me why they still call it a dual mandate).

So it should be no surprise, then, that the Fed has now gone way beyond that dual (or treble) mandate by wholeheartedly injecting itself into what is really a political debate, namely climate change. And how ironic it is that it rose to the forefront during the same week that the U.S. withdrew from the Paris Climate Agreement.

Last week Fed officials were out in force, declaring that climate change would now be a major factor in not only how it regulates federally chartered commercial banks but also how it conducts U.S. monetary policy.

On Thursday, in a speech at the GARP Global Risk Forum, Kevin Stiroh, an executive vice president responsible for regulating banks at the New York Fed, said financial firms need to take the dangers and costs of climate change into their risk-management decisions.

“Climate change has significant consequences for the U.S. economy and financial sector through slowing productivity growth, asset revaluations, and sectoral reallocations of business activity,” he said. “The U.S. economy has experienced more than $500 billion in direct losses over the last five years due to climate and weather-related events.”

While noting that “it is beyond our mandate to advocate or provide incentives for a particular transition path,” Stiroh said financial regulators “can use our tools to ensure financial institutions are prepared for and resilient to all types of relevant risks, including climate-related events.”

That was a prelude to Friday’s big event, namely the San Francisco Fed’s conference on climate change and economic risks.

“Climate change is an economic issue we can’t afford to ignore,” Mary Daly, the president of the bank and host of the conference, said. “There’s little doubt that we need to recognize, examine, and prepare for these risks in order to fulfill our core responsibilities.”

Earlier in the week, Daly said, “I don’t see that as anything outside of our mission. In fact, I think it’s squarely in our mission and important for us to do that.”

She was seconded by Atlanta Fed leader Raphael Bostic, who told reporters “that addressing climate-change issues is a core responsibility for the central bank now,” according to the Wall Street Journal.

That brought up Fed governor Lael Brainard, who said, “If prices of properties do not accurately reflect climate-related risks, a sudden correction could result in losses to financial institutions, which in turn reduce lending in the economy,” she said. “Banks also need to manage risks surrounding potential loan losses resulting from business interruptions and bankruptcies associated with natural disasters.”

So far, all of this sounds reasonable, since financial losses could certainly affect banks’ safety and soundness. But Brainard went well beyond the possible impact of climate change on the commercial banks that the Fed supervises too how it could affect Fed monetary policy, which seems like a huge reach.

“To the extent that climate change and the associated policy responses affect productivity and long-run economic growth, there may be implications for the long-run neutral level of the real interest rate, which is a key consideration in monetary policy,” she said.

Now, regardless of your thinking on climate change, it should baffle you why, when the Fed has a hard-enough job conducting monetary policy with quantifiable or fairly accurate data at its disposal – inflation, employment, economic growth, retail sales, capital expenditures, stock market performance, bond yields, loan demand, etc. – it is planning to add into its calculations events that are totally unpredictable, be they hurricanes, high (or low) temperatures, forest fires, snowfall, rainfall, drought, earthquakes, tsunamis, typhoons, etc., etc.

Do all of those things result in monetary damages? Certainly. They always have and always will. Do smart businesses, banks, and people in general already prepare for those things the best they can by putting money aside for them or borrowing money if they need to after the fact? Yes.

But conducting monetary policy? How will the Fed actually do that? And, perhaps most importantly, what if it’s way off in its forecasts, as it has proven to be over the past several decades without adding climate change into the mix?

Brainard herself noted the challenges in doing that.

“Because there is considerable uncertainty about the persistence, breadth, and magnitude of climate-related shocks to the economy, it could be challenging to assess what adjustments to monetary policy are likely to be most effective at keeping the economy operating at potential with maximum employment and price stability,” she said in her San Francisco speech.

No kidding.

The Fed makes enough bad calls on monetary policy and bank regulation using what it does know. Imagine what we can expect when the Fed tries to predict the weather.

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George Yacik Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.

2 thoughts on “The Times They Are A' Changin'

  1. The Fed is caught between a rock and a hard place.

    The rock, on the one hand, is the already immensely complex challenge of making policy decisions which by definition are designed to affect the plans and decisions of corporations and individuals, both domestically and around the globe. Those decisions inevitably have unintended and unpredictable consequences, both small and large. The care with which each report from the FOMC is crafted is a reflection of their efforts to limit those consequences, and, it would seem, it is also a tacit acknowledgement of their limited ability to predict them.
    The fairly steady decline in the velocity of money over the past 2 decades has certainly run contrary to their intentions for large parts of that time frame.

    On the other hand we have the hard place of climate change and the limited data set with which climatologists work. As Mr. Tenebrarum implies, given the complexities of weather and climate, it will certainly be dumb luck if those scientists were to get the details of their predictions right. We won’t fully appreciate what climate change will look like until it is upon us.

    That said, the challenges of the scientists look to be more straightforward than those of the Fed. Indeed they (climatologists) very likely already the big picture right, and that picture is rather grim. And a significantly warmer planet Earth will entail profound economic change. It only makes sense then for the Fed to include that in their deliberations and to attempt to “use our tools to ensure financial institutions are prepared for and resilient to...climate-related events.” They may not get the details right, and given their track record it seems likely their will be casualties along the path ahead regardless of their actions, but to avoid action seems much the poorer choice here.

  2. Not even the people who are supposed to be experts at predicting the weather are able to predict it with accuracy. It is far worse with those supposedly tasked with predicting the climate (a.k.a. long term weather conditions) - their modeled forecasts have been so utterly wrong over the years (vastly overestimating the degree of warming), they make economists look like descendants of Nostradamus.

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