Financing the Green Transition through Off-Balance-Sheet Fiscal Agencies

In recent years, there have been increasing calls to make central banks agents of broader socio-economic change for pursuing environmental goals. But are central banks the most suitable actor to finance a Green transition?

First, it is not obvious that the central bank balance sheet should be tailored to support Green assets. Some argue the ECB’s operations are biased towards ‘brown’ assets. Greening the operations would have to imply abandoning the market neutrality principle, shunning the bonds of carbon-intensive sectors, and replacing the eligible bond universe with green and low-carbon bonds. That said, these propositions run into the danger of undermining the core mission of central banks, which have led them to play today’s dominant role: defending financial stability and acting as lender of last resort.

Second, central banks' monetary operations nowadays rely on market-based forms of finance. This presents obstacles for a central bank-driven green transition. Albeit growing rapidly, the green bond market is but a fraction of the overall bond market. When central banks increase the incentives for issuing green bonds, they might also water down what counts as environmental impact – in particular due to the lack of unified and homogeneous standards for green bonds. Therefore, simply using the tools of monetary policy to address the environmental issue does not guarantee the right projects are funded.

Third, readjusting the purpose of central banking means abandoning an important dimension of the balance of power in modern political economies. A worrying possibility is that less progressively inclined but democratically elected leaders might employ central banks’ firepower for nefarious, clientelistic, or self-serving purposes.

Dr Andrei Guter-Sandu is a postdoctoral fellow at the Center for Analysis of Risk and Regulation at the London School of Economics and Political Science. Dr Steffen Murau is a postdoctoral fellow at the Global Development Policy Center of Boston University and Affiliate Scholar at IASS. They won a prize in the Hertie Foundation’s essay competition on “Democracy and Economy” with a co-authored piece on democratizing the Eurozone architecture. In their contribution, they identify that since the Eurocrisis there is a tendency to set up “off-balance-sheet fiscal agencies” to mitigate fiscal constraints inscribed in Eurozone governance. To increase democratic legitimacy, they propose putting those off-balance-sheet fiscal agencies under the budget authority of the European Parliament. Their essay has been published by "Wirtschaftswoche" in October 2020. In this blog post, they reflect on the implications of their argument on the Green transition towards a more sustainable economy.

There is, however, another way to mobilize funds for the green transition which is less prone to undermining important achievements in the institutional balance of the Eurozone: Financing the Green Transition through off-balance-sheet fiscal agencies (OBFAs).

New Fiscal Agencies

OBFAs make use of ‘grey areas’ in the Eurozone’s regulatory framework. Yet they offer policy space for activities that Eurozone treasuries do not normally have. National treasuries are bound by tight fiscal rules, for example through the Stability and Growth Pact, the Fiscal Compact, and the European Semester. The EU ‘treasury’, despite the latest innovations via the EU Council’s compromise, is dependent ex ante on household planning through the Multiannual Financial Framework and has no autonomous rights to raise taxes or issue bonds to a large extent. In this context of fiscal discipline, national and supranational OBFAs support the functions of treasuries in several respects.

One of the functions of those OBFAs is to increase the scope for public investment. It has been noted that the Eurozone suffers from underinvestment, in particular to support the Green transition. Still, we have seen an expansion of fiscal space on OBFAs through the revival of state banks and state development banks such as the German Kreditanstalt für Wiederaufbau and the French Agence Française de Développement, or—on a European level—the European Investment Bank, the European Investment Fund and the European Bank for Reconstruction and Development. These organizations have been pivotal to building a so-called “hidden investment state” at the heart of the EU and there are ongoing considerations to further expand their usage.

Financing the Green transition

In our article for "Wirtschaftswoche", we propose putting the Eurozone’s OBFAs under the budget authority of the European Parliament to combat the democratic deficit of today’s Eurozone architecture and find a feasible form of ‘fiscal union’ in the Eurozone. Similarly, such OBFAs could become frontline agents in financing a Green transition. Not bound by the strict rules governing treasuries, they can increase the scope for green public investment. OBFAs can for instance emulate national treasuries’ traditional function of financing infrastructure, mobility, and energy systems but of a greener denomination. They can finance the development of urban cycling and rail infrastructures, or of low-emission vehicles for public transport in rural areas; they can also finance green public housing and renewable energy sources. They can furthermore finance land and forest conservation programmes, as well as secure water supply projects.

As OBFAs are implicitly linked to treasuries via contingent asset and liability chains, they can fund projects at preferential interest rates. They can issue green bonds to finance their operations and, in the process, create new safe assets to satisfy the insatiable thirst of investors for such securities in the Eurozone. And because public investment OBFAs are diverse and multiple—they have different goals and are present in various places—they can even enhance stakeholder participation and contribute to better resource allocation by drawing on localised knowledge and expertise.

Monetary policy is not an obvious instrument for tackling grand challenges. Better if central banks remain enablers of financial stability and lenders of last resort for emergency liquidity rather than front row agents of policy change. They may contribute to fiscal stimulus by keeping long-term borrowing cheap, while letting democratically controlled OBFAs pursue their targeted missions and finance a Green transition.

This blog is based on an essay that was published on 24 November 2020 under the title "Putting 'off-balance-sheet fiscal agencies' under the control of the European Parliament could help democratize Eurozone government" in "LSE Europp" as a blogpost by Andrei Guter-Sandu and Steffen Murau.