The Greening of the Federal Reserve

Powell endorses bank stress tests to allocate capital for climate policy.

ByThe Editorial Board

Jan. 11, 2022

Federal Reserve Board Chairman Jerome Powell listens during his re-nominations hearing of the Senate Banking, Housing and Urban Affairs Committee in Washington, D.C., Jan. 11.

Jerome Powell faced the Senate Banking Committee at his confirmation hearing for a second term at the Federal Reserve on Tuesday, and it's a sign of the progressive times that a leading issue was the greening of the central bank. Not green as in money, but as in climate regulation.

Mr. Powell didn't break any news on monetary policy, which is his main job. He stuck to his recent talking points that inflation has run hotter than expected, though not because of any Fed mistake. It's all the result of a supply and demand mismatch caused by the pandemic, not from an excessive supply of money to the economy.

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The wheels seem greased for Mr. Powell's confirmation if only because the alternatives are thought to be worse. We're not sure about that, and on that score one issue to watch is how the Powell Fed uses its regulatory power to drive lending and investment out of fossil fuels and into renewables.

Mr. Powell seems fired up for the job. The Chairman on Tuesday endeared himself to progressive Senators by agreeing that the Fed's role in climate change is "limited" but "important." He also said climate stress tests for banks will likely "be a very important priority" in supervision.

"I think it's very likely that climate stress scenarios, as we like to call them, will be a key tool going forward," he added.

But why? Climate policy isn't part of the Fed's dual mandate, which is to ensure stable prices and maximum employment. Having botched inflation in 2021, you'd think the Fed would focus on that.

But Mr. Powell is nothing if not political, and the left is pressing the Fed to adopt climate bank stress tests. Their concern isn't whether bank balance sheets can withstand extreme weather or warming temperatures. A New York Federal Reserve Bank staff study last fallfoundthat banks benefit from extreme weather events because they spur increased lending.

Instead, the left wants the Fed to use stress tests to make banks reduce and eventually eliminate financing for coal, natural gas and oil development. Banks would have to adjust their balance sheets to take account of the risks from government climate policies like mandates, regulation or carbon taxes. To pass the climate stress tests, banks would have to liquidate fossil-fuel assets.

This is political allocation of capital, which also isn't the Fed's job and brings its own risks of financial instability. Last week news broke that President Biden is considering former Treasury official Sarah Bloom Raskin to be Fed vice chair for financial supervision. Ms. Raskin in September wrote anop-edtitled "Changing the Climate of Financial Regulation" for the Project Syndicate endorsing bank stress tests, living wills and risk-based capital standards to advance the left's climate agenda.

Rhode Island's Sheldon Whitehouse, the Senate's leading wind producer,tweetedthat her nomination would be "good news," since she "really gets it on climate. When that bubble bursts, it's going to be hell. We have to prepare, and she will try." Sen. Sherrod Brown, the Banking Chairman, said she would be "terrific" on climate regulation and also "I assume, will be good on monetary policy too."

For Democrats these days, an economist's credentials on monetary policy are now second to climate for a position on the Fed Board of Governors. One irony is that government anti-carbon policies are driving what some economists call "greenflation"an increase in commodity and energy prices on everything from oil and gas to lithium and copper.

Investment in fossil fuels has fallen sharply even though consumer demand hasn't. Behold Europe's climate crack-up, which has resulted in soaring energy costs. Meantime, government policies have boosted demand for green energy, but the supply of minerals needed to make batteries for electric cars, solar panels and wind turbines is lagging, driving prices higher.

European Central Bank executive board member Isabel Schnabel last weekend warned: "The combination of insufficient production capacity of renewable energies in the short run, subdued investments in fossil fuels and rising carbon prices means that we risk facing a possibly protracted transition period during which the energy bill will be rising. Gas prices are a case in point."

Federal Reserve chairmen ought to stay out of the capital allocation game, but Mr. Powell seems to think this is now part of the Fed's job. This is how central banks get into political trouble, which leads to financial trouble.

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