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Op-Ed | The American Prospect | August 24, 2023

Jay Powell’s Legacy Depends on Whether He Steps Up on Climate Risk

Climate and EnvironmentFederal ReserveFinancial Regulation
Jay Powell’s Legacy Depends on Whether He Steps Up on Climate Risk

In advance of his Jackson Hole speech, the Fed chair has neglected his role of ensuring the safety and soundness of banks with substantial fossil fuel assets.

This article was originally published by The American Prospect. Read on the original site here.

This week, the Kansas City Federal Reserve hosts the annual Jackson Hole Symposium, an invite-only, semi-private retreat where international central bankers, Fed officials, select media, and academic economists gather to discuss the state of the economy and new research. This year, the event’s theme is “Structural Shifts in the Global Economy,” an academic title for “what we learned from COVID.”

Inevitably, the conference will celebrate the once-mythical “soft landing” that the U.S. economy appears poised to pull off. The falling inflation rate without a recession was once thought impossible by economists like Larry Summers. Fed Chair Jerome Powell will be front and center of the retreat, eager to take credit for lowering inflation through interest rate hikes. But the victory lap would be a myopic choice, given that Powell’s Federal Reserve has left the biggest threat to global economic stability unaddressed: climate change.

Whether Powell deserves credit for the falling inflation rate (we agree with Paul Krugman that he mostly does not) is beside the point. What matters is that Powell assumes the soft landing will be his defining legacy, an integral part of a friendly narrative that includes quickly pulling out of the COVID recession, returning unemployment to low levels, and crushing inflation without causing job loss or a recession. 

The problem, of course, is that inflation isn’t the only disruptive force that we’re up against. If Powell fails to use the crucial next few years to address the systemic risk climate change poses to the U.S. and global economy, the climate (to say nothing of all living creatures) will not be the only thing to suffer. So too will his legacy as Chair of the Fed. 

Climate change poses a grave threat to the well-being of key economic institutions. Since 1980, the U.S. has sustained more than 360 extreme weather events in which damages reached or exceeded $1 billion—109 of which have occurred since 2017 alone. The combined financial cost of those disasters, which killed nearly 16,000 people and disrupted the lives of millions more, is roughly $2.6 trillion, adjusted for inflation. Meanwhile, as greenhouse gas pollution continues to soar, extreme weather events are happening with increasing frequency. Projections of future climate-driven economic losses are staggering

All of this poses a massive threat, not only to communities but also to banks and other financial institutions invested in the fossil fuel companies responsible for the majority of global emissions. That’s particularly true now that national policy is putting hundreds of billions of dollars toward electrification and renewable energy. A recent report showed that the world’s 60 largest banks have an estimated $1.35 trillion of exposures to fossil fuel assets.

Insurance giants have already begun to limit coverage in hundreds of disaster-prone areas across the U.S. as a result of the worsening climate chaos, even as they continue to invest in planet-wrecking fossil fuel projects. AIG intends to scale back home insurance sales in about 200 ZIP codes at elevated risk of floods or wildfires, a decision that will affect parts of Colorado, Delaware, Florida, Idaho, Montana, New York, and Wyoming. Earlier this year, Farmers Group stopped accepting new applications for home insurance policies in Florida, citing hurricane exposure and the escalating costs of rebuilding. Louisiana and California residents are also enduring the consequences of the insurance industry’s retreat. As larger chunks of U.S. real estate become uninsurable, it will become increasingly difficult for housing consumers to obtain mortgages in wide swaths of the country. As a result, many areas are poised to see a crash in property values, a decline in local tax revenues, and a subsequent collapse in funding for social services. 

At the same time, rising demand for renewables and falling demand for oil and gas threatens to leave behind stranded fossil fuel assets. This is not insurmountable; research has found that potential financial losses from the clean energy transition are concentrated among the wealthy and relatively inexpensive for governments to compensate, bolstering the case for swiftly winding down the fossil fuel industry. But it is something that needs careful monitoring from financial regulators to mitigate risk.

If the specter of a climate-induced financial crisis sparking an austerity doom loop doesn’t compel the Fed to acknowledge and act on these systemic risks, what will? Powell and his colleagues must understand that making logical regulatory choices now will save trillions of dollars later.

Fortunately, the Fed has a bevy of tools at its disposal to help avert the worst consequences of the climate crisis. One of the most significant steps the U.S. central bank could take is to require systemically important financial institutions (SIFIs) to divest from carbon-intensive industries as a risk-management measure. The Fed can also mandate that climate risks be factored into banks’ stress tests. In addition, the Fed can incorporate climate risks into its own supervisory and examination work. Not only does the Fed have the authority to expedite the greening of the economy, but climate action falls squarely within its responsibility to manage macro-scale risks to the financial system.

There is no better forum for Powell to announce a policy shift toward reducing climate risk than at Jackson Hole. Not only can Powell now tangibly claim that the immediate threat of inflation has ended (and thus defend himself from any Republican attacks that climate risk mitigation is a distraction from “real issues”), but his counterparts in other countries are already making important, if insufficient, efforts in this area. Specifically, some of the Fed’s peers abroad are actively exploring or implementing mandatory disclosure rules, improved climate stress tests of banks’ assets, and direct investment or lending policies that favor green enterprises. The Fed remains a laggard by contrast. But the symposium, as a gathering of central bankers from around the world, offers Powell an opportunity to position the U.S. as a leader in confronting climate risk.

As the central bankers of the world’s reserve currency, the Fed has an obligation to lead efforts to reduce climate risk. The failure to regulate threatens not only America, but the global economic system more widely, as large disruptions to the U.S. economy can plunge the rest of the world into a recession. This makes a Fed intervention to prevent excess climate risk not only something to be welcomed by climate activists, but by our nation’s largest trading partners. 

Powell has previously opposed calls for the Fed to use its regulatory powers to mitigate the risks posed by climate change, saying, “We are not, and will not be, a ‘climate policymaker’.” But Powell fails to recognize that continuing the status quo is in fact a policy decision, one which subsidizes risky investments while hastening and intensifying climate change and financial crises. Climate policymakers are not limited to those working to lower greenhouse gas emissions. An agency whose policies neglect the pace of climate change and the energy transition is also shaping the future of our climate and our economy. 

Much of Powell’s opposition to climate mitigation regulation purportedly stems from his desire to protect the Fed’s appearance of political independence. Over the past year, Powell has witnessed Republicans lash out against SEC Chair Gary Gensler for the agency’s rules that will require the disclosure of climate-related risk. In November 2022, then-Senator Pat Toomey attacked the Fed’s pilot climate analysis as an attempt by unelected bureaucrats to drive carbon-emitting industries into bankruptcy. While this is obviously not the case, the critique has been furthered by Republican bills introduced this year aimed at preventing the Fed from ensuring banks properly account for their climate risk. 

Powell cannot fold in the face of these preemptive attacks, especially since they are merely unsigned legislative drafts rather than actual law. Determining policy based on complaints from lawmakers itself erodes the independence the Fed purportedly relies on. 

While climate activists may be the most vocal proponents of climate risk mitigation, the Fed should recognize that this is indisputably an issue of financial stability. Powell does not need to be an environmentalist in order to implement stringent climate risk regulations. As Fed Chair, Powell has an obligation to ensure the long-term stability of the banking sector. By steadfastly avoiding Republican attempts to label him an environmentalist, Powell is failing to contend with a looming financial threat: a clear dereliction of his duty. 

Climate and EnvironmentFederal ReserveFinancial Regulation

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