Monetary and macroprudential policies: How to Be green? A political-economy approach

This study examines the trade-offs that central banks would face if they began addressing climate change. The various instruments available to address climate-related risks overlap with those currently used for monetary and macroprudential purposes. However, most existing literature fails to adequately consider the political-economy aspect of this phenomenon. This creates a bias in favor of interventions by central banks. Using a political principal–agent setting that eliminates this bias, we examine the conditions under which the central bank architecture could effectively pursue this goal without compromising its core mandates. The effectiveness of central banks depends on their ability to calibrate, maintain independence and demonstrate a degree of activism. • This study identifies trade-offs central banks face when addressing climate change. • Tools for reducing climate risks overlap with those for monetary and macroprudential mandates. • We use a principal–agent model to analyze central bank's conditions to address climate change. • Central banks' effectiveness depends on calibration capacity, independence, and activism.