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The Federal Reserve’s Role in Saving the Planet

Words by 3p Contributor
Investment & Markets
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By Joseph Plummer

Climate change is perhaps the most significant case of unmitigated externalities in an economy in the history of mankind. We have a market that is somewhat regulated. But for the most part, the external costs associated with producing greenhouse gases are not accounted for in any part of our economy. In other words, even though greenhouse gases are causing significant damage to the environment, no one is being compensated. This makes sense, because no one owns the atmosphere or the ocean or the air or entire ecosystems. Who would you compensate?

There is a legitimate argument to be made for polluters to pay some sort of carbon tax that would effectively reduce the impacts of greenhouse gases by making it more costly to emit them. Also, the revenue from the carbon taxes would at least partially fund mitigation efforts. But carbon taxes really wouldn’t solve the problem. Polluters would continue to pollute, and mitigation efforts would only make things less bad and not better.

Another legitimate argument is just to regulate the market in such a way that it is very difficult to produce greenhouse gases. This is a very costly method, because it relies on companies and individuals being able to adhere to such regulations. This would mean companies and individuals must make changes to follow the law, at their own expense, and would most definitely have significant slowing effect on the economy. Money diverted to adhering to government regulations is money that isn’t being spent on other things. Also, the cost of regulating effectively would be significant, as greenhouse gas emissions come from every facet of our economy.

So, if we accept the facts that carbon taxes will be ineffective and carbon regulation will be extremely costly, then what options are we left with? How do we halt greenhouse gas emissions in a timely manner without slamming on the brakes of our economy?

As it turns out, this is an easy problem to solve that doesn’t require action by Congress or the president. Basically, we need money to address climate change, and we don’t want to take money from economic progress or other current public initiatives. Consider that constraint for a moment. How can a society transition to a carbon-free economy in a timely manner without using tax revenue and without excess burden on individuals and businesses? We need more money.

The current definitions and constructs related to money demand are obsolete. These definitions and constructs were developed before the Information Age, before the interstate highway system, before we landed on the moon, and before climate change. It is time to include climate change (and other externalities) in our understanding of money demand.

The Federal Reserve is an independent government entity, and all of its monetary policy decisions can be made without approval from the president or Congress. So, that’s kind of amazing. The Federal Reserve can inject money whenever it decides it is necessary without getting approval from Congress or the president or anyone else for that matter. So, how do you convince the Federal Reserve Board to inject more money into the economy?

The Federal Reserve has a very clear mission that includes three basic objectives: maximize employment, keep prices stable and keep interest rates reasonable. The Federal Reserve is also responsible for “containing systemic risk that may arise in financial markets."

Given the objectives mentioned, take a moment to strategize on how you might convince the Federal Reserve to take a more active role in addressing climate change. Note: We don’t have to convince the Fed to inject capital into the economy for the purposes of addressing climate change. We need to convince them that if they don’t inject capital to address climate change, then prices will become unstable, unemployment will increase, and systemic risks will arise in financial markets around the world. This is an easy argument to make.

As global sustainability leaders develop and consider macro-level solutions to climate change, they should keep in mind the unique power that central banks have. Furthermore, in the case of the Federal Reserve, we don’t need to worry about the combative relationship between Congress and the president. The Federal Reserve might be the only player in this global game of chicken that can act swiftly enough to address the massive global problem that is climate change.

Image credit: Wikimedia Commons

Joseph Plummer is a degree candidate in the Executive Master of Natural Resources (XMNR) program at Virginia Tech, expecting to graduate in May 2016.

3p Contributor

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