the Bundesbank Research Centre has released a new Discussion Paper:
https://www.bundesbank.de/discussionpaper

Authors: Francesco Giovanardi, Matthias Kaldorf, Lucas Radke, Florian Wicknig

Non-technical summary

Research Question

In its recently concluded strategy review, the ECB decided to place a larger weight on climate change considerations in their monetary policy decision-making. One particular instrument to address climate change in the implementation of monetary policy is the preferential treatment of corporate debt-securities linked to environmentally-friendly investment projects (so called green bonds) in the ECB collateral framework. This instrument intends to improve financing conditions for sustainable investment and could, thereby, contribute to climate change mitigation.

Contribution

The preferential collateral treatment of green bonds is a novel monetary policy instrument and neither its effectiveness to stimulate sustainable investment, nor its potential adverse side effects are sufficiently well understood. Our paper augments a real-business cycle model by environmental and financial frictions to isolate welfare relevant channels of a preferential policy and to conduct various policy experiments. Contrary to previous literature, our analysis explicitly takes into account the endogenous leverage decision of bond issuers, which facilitates a more accurate description of the financial market effects of a preferential treatment policy.

Results

Our analysis yields four main results. First, the preferential treatment of green bonds does have a positive effect on sustainable investment. Calibrated to the euro area, a reduction of the green collateral haircut from 26% to 4.5% (based on ECB-haircuts for BBB and A-rated corporate bonds) would increase sustainable investment by 0.5%. Second, this policy induces a higher leverage-ratio of green firms. This adverse side-effect implies that the welfare-optimal haircut on green bonds is 10%, which only increases sustainable investment by 0.4%. A preferential collateral policy is welfare-enhancing despite this adverse side effect, as long as carbon taxes remain at the inefficiently low level of today. Third, the real effects of a preferential policy fall well short of what an optimally set carbon tax would achieve, which (in our calibrated model) would increase green investment by around 40%. Finally, we show that a carbon tax does entail adverse side effects on the leverage-ratio of green firms. Therefore, compared to a preferential collateral policy, a direct tax is a qualitatively and quantitatively more effective instrument to address climate change.