Q&A: The role of financial policies in climate action

Financial and monetary policies are key when it comes to achieving the Paris Agreement on climate change, according to José Antonio Ocampo, professor at the School of International and Public Affairs at Columbia University and chair of the United Nations Committee for Development Policy.

They can play a crucial role in “mobilizing mainstream finance to move toward a greener economy” while helping to mitigate the effects of shocks and disasters. And for countries with economies that are largely based on oil and coal, implementing financial policies can also help them transition to new sources of energy and to diversity exports, Ocampo explained.

The Human Development Report 2020, “The Next Frontier: Human development and the Anthropocene” — of which Ocampo was a contributor — explains that financial policies can help ensure the cost of climate risks are reflected in financial markets and regulatory frameworks.

Speaking to Devex, Ocampo explained the role of financial, monetary, and macroeconomic policies in paving the way toward lower greenhouse gas emissions and climate resilient development and how to put such policies together.

This conversation has been edited for length and clarity.

How are climate change and finances interlinked?

First, many countries — like Colombia, South Africa, countries in the Middle East — are exporters of oil and coal. These economies must diversify their export structure, their energy production, and their fiscal resources to be less dependent on sectors that are carbon intensive.

Then, there is a broader set of changes that apply to all economies.

The first is financing the transition to new sources of energy production and consumption. This is something the development banks — multilateral and national — have a very important role in financing solar, wind, and hydroelectric energy production to reduce carbon emissions.

In Latin America, there’s also the problem of how to avoid deforestation, which is a major source of carbon emissions and has other environmental impacts. Again development banks can play a very important role.

Then there are financial risks — i.e., possibly losses — that multiple companies face, and not only energy producers but also firms that use energy in different forms. They may be associated with technological developments that change the production of energy and the use of energy in the industrial sector.

They may also be related to the behavior of consumers that are increasingly conscious of the climate change transition and may prefer to consume goods that include a lower carbon emission.

There are also risks associated with the policies that would be adopted to manage the energy transition, particularly because — as many others — we support the use of carbon taxes, which must increase in all economies in the world in order to manage this transition.

There are, thus, a whole set of risks which are financial risks that private firms must take into account. This means that managers and bankers must start to incorporate these risks into their analysis … to avoid severe effects that they may face later on. Some European oil companies are already diversifying and investing in other forms of energy production. 

Finally, these issues must also be fully incorporated into economic analysis.

When thinking about reimagining development in a way that’s cognizant of planetary pressures, what role can macroeconomic policies play?

First of all, the macroeconomic policies in economies that depend heavily on exporting oil and coal must aim at diversifying their exports and their public sector financing to depend less heavily on fossil fuels.

Second, taxes on carbon emissions must increase in a consistent way. Very few countries have high emissions taxes today, but they are important and should become a major source of government revenue and could be used to subsidize moves towards mitigating, and adapting to, climate change.

Third, the development banks, which are effectively owned by governments, must be able to finance new forms of energy production and consumption.

Finally, as part of their asset accumulation policy, central banks — and, particularly, developed countries’ central banks — can include in their portfolios bonds or even stock of firms that are investing in the energy transition.

What does a good financial and monetary policy for climate change look like?

First of all, there should be specific financing for climate change mitigation and adaptation with the support of the development banks. Second, a very strong regulatory supervision of financial institutions that takes into account the risks associated with climate change. Third, what I mentioned about the portfolio of central banks.

Last, but not least, something that is already happening — which I think is one of the fantastic things that’s going on — is that the International Monetary Fund, the European Central Bank, and many other central banks are at the center of analysis of climate change issues and starting to promote activities that are friendly to the Paris Agreement.

What are the first steps in putting such policies together?

Developed countries have been the major source of carbon emissions and so have a major responsibility in trying to reduce emissions.

The majority of developing countries must also join, because it's quite clear that global targets set by the Paris Agreement cannot be reached without the emerging and developing countries, some of which are now also major sources of emissions.

And, as already underscored, countries that depend on exports of coal and oil must diversify their economic structures away from carbon intensive sectors.

This focus area, supported by the U.N. Development Programme, explores how climate change and other planetary imbalances impact the rising trend of human inequality and vice versa. Visit the Focus on: People and the Planet page for more.