This year, Europe is confronted with a critical double challenge: addressing the climate change issue and pulling itself out of a persistent low growth trap. Today these two challenges are addressed separately:
- climate negotiations must reach a historical agreement in the Paris conference in December 2015
- the Juncker Plan of 315 billion euros of investment, and above all the ECB announcement of a massive purchase of assets for an amount of around 1100 billion euros, must help to avoid a deflationary spiral and stimulate a new flow of investments.
This policy brief puts forward a common framework for these two problems.
The History of climate negotiations shows how difficult it is to let a carbon price emerge. The carbon price and the emission quotas are theoretically the best instruments to internalise the price of the externality induced by each emitted unit of CO2. In practice though such a climate policy rapidly encounters a strong social opposition on the side of households and firms, for which it translates into important costs.
In order to circumvent this opposition and both better smooth the efforts while credibly engaging into the low carbon transition, this note proposes to make private low carbon assets eligible for the ECB asset purchase program. The low carbon nature of the assets would have been previously certified and guaranteed by the government. In fact, by restraining itself to assets traded on the secondary markets, the ECB limits its leverage on new investments, and thus on the scope of the recovery and the quality of growth. The proposed mechanism on the contrary implies a financial mechanism targeted towards new low carbon investments, which guarantees a faster and more sustainable recovery.
This tool would allow for a low carbon direction to the investment component of a European recovery strategy.
The originality of the proposal lies in the joint implication of the public and the private sector to send a signal on a carbon value, which is immediately high in order to guide the new investments in the (temporary) absence of an adequate carbon price. This would allow for making new low carbon investments profitable without penalizing the existing capital stock. It thus induces an immediate effect on investment decisions while allowing for a more progressive increase of the carbon price. Moreover, the states are strongly incited to put in place a carbon pricing mechanism so that the guarantee they bring on the value of the carbon assets be neutral for the public budget.
This proposal of a low carbon financial intermediation backed on carbon lies on five main principles:
Defining the social cost of carbon (SCC)
It is neither a market price, nor the tax incorporated in the prices of goods. It is a notional price defined as the social value of avoided CO2 emissions. Available estimates of the SCC cover a wide range of values, depending on assumptions made regarding key socio-economic parameters. This is why the SCC ultimately rests on a political agreement.
Defining an amount of carbon assets benefiting from a public guarantee
Governments commit to guaranteeing the value of carbon assets at the level of the SCC for a given period and a given amount of carbon assets, consistent with their domestic contribution to the global climate policy. This value is renegotiated upwards (as forecasted by most models) at the end of the commitment period. The key element here lies in the predictability of the signal on the value of avoided CO2emissions.
Certifying emission reduction
An independent body would be in charge of monitoring low-carbon projects. It would define a typology of low-carbon projects and methodologies to appraise emission reduction according to the technologies, sectors, and time horizons of the projects.
Accepting the carbon certificates in the balance-sheet of the monetary institution
The central bank announces that it is ready to refinance the low carbon loans delivered by commercial and development banks up to the value of effective emission reductions, that is the value of the carbon certificates.
Redirecting long term savings
In addition to mobilizing the bank credit channel, this instrument also provides leverage to redirect the stock of savings towards lower carbon investments. The fact that the central bank accepts to « pay » for the emission reductions at their social value brings a sufficient guarantee to conceive, through specialized funds, a whole new range of highly rated financial products backed by carbon certificates.
Through the use of taxes and quotas, the government slowly increases the price of carbon so that it remains tolerable for the existing carbon intensive investments, but generates at the end a sufficient revenue to honor the public guarantee on the carbon certificates.
The proposed mechanism is a form of controlled quantitative easing (through the new carbon metrics), which improves the quality of growth. It also reinforces the non-price competitiveness of Europe thanks to the spillover effects of transportation and energy sectors on all the sectors of the economy.
Compared with policies which only act on the implementation of a carbon price, with little success so far, the proposed scheme allows for the direct mobilization of the resources offered by bank credit and savings at the service of an energy transition.
The European Union should initiate such a junction in 2015, promote a monetary policy at the service of European investment and climate in order to give a low carbon direction to future growth and thus reinforce its historical leadership on climate questions. The influence of Europe on developing countries during the Paris Conference in December 2015 will largely result from its ability to prove that a sustainable prosperity and an ambitious climate goal go hand in hand.