By pulling out of the Network for Greening the Financial System (NGFS), the Federal Reserve (Fed) probably wants to get on good terms with Donald Trump. This shows that the US central bank might also cave to political pressure on its interest rate policy.
In my previous column, I discussed the exodus of the largest US financial institution from global climate alliances, prompted by Trump's election victory. Sustainability ambitions announced with much fanfare were just as easily watered down when the political winds shifted. Potential political backlash apparently far outweighed the loss of credibility.
If there is one institution to which this should not apply, it is a central bank. After all, trust in it is based on its perceived political independence. This trust is an important prerequisite for successful monetary policy and a minimum level of stability in financial markets.
It is therefore highly remarkable that the Fed recently joined the ranks of the pragmatic and Trump-fearing. The US central bank exited the NGFS, which it had joined only four years ago.
The NGFS is an international partnership of central banks and regulators aimed at greening the financial system and increase the financial sector's efforts to meet the Paris climate goals.
Wrongly hiding behind its mandate
That political pressure led to the Fed's decision is evident from the reasoning given for its departure. When the Fed joined the NGFS, it wanted to “broaden its understanding of the impact of climate change on the financial system.” According to the Fed, the activities of the NGFS have since expanded so much that many issues now fall outside the Fed's legal mandate.
The NGFS has indeed widened its scope by also looking at other ‘nature-related’ financial risks, such as biodiversity loss. This in itself is useful knowledge that can help ensure financial stability, but even if the Fed were willing or allowed to focus only on climate change, these risks are highly relevant. Gaining insight into such themes is exactly why the Fed joined, in its own words, four years ago.
Recently, the NGFS has also started to focus more on macroeconomic impacts of climate change, with an explicit focus on employment. As the Fed is one of the few central banks whose mandate includes both price stability and maximum employment, the network seems to have only become more relevant in this regard as well. That the Fed will not make more use of this knowledge is worrisome. It increases the likelihood of misjudged risks, potentially leading to financial turmoil in the U.S. and, by extension, the global financial system.
Political headwinds appear to be real reason
In the short term, the departure exposes an even bigger problem: Fed chairman Jerome Powell appears sensitive to political pressure. Just a few months ago, he explicitly stressed that the Fed is and remains independent, saying that the president is not legally authorised to dismiss Fed members. He even suggested he would enter a legal battle if Trump attempted to gain influence via that route.
The political independence of Western central banks has for decades been the foundation on which financial markets' confidence in the monetary system has been built. Once investors start doubting this independence, chaos in the markets is not far off. So far, it seems that investors do not see the Fed’s departure from the NGFS as a sign of Powell's weak knees. But what if Trump steps up the pressure soon and demands lower interest rates, for instance?
This column was originally published by Financial Investigator.
