It is clear to everyone that decarbonization is happening far too slowly. Even the best-performing high-income countries are not reducing their emissions fast enough to achieve the Paris Agreement objectives—not even close. And one big reason is that even though renewables are now routinely cheaper than fossil fuels, they are still not nearly as profitable. Returns on fossil fuel investments are around three times higher than returns on renewables, largely because fossil fuels are more conducive to monopoly power while the renewable sector is highly competitive.
It is clear to everyone that decarbonization is happening far too slowly. Even the best-performing high-income countries are not reducing their emissions fast enough to achieve the Paris Agreement objectives—not even close. And one big reason is that even though renewables are now routinely cheaper than fossil fuels, they are still not nearly as profitable. Returns on fossil fuel investments are around three times higher than returns on renewables, largely because fossil fuels are more conducive to monopoly power while the renewable sector is highly competitive.
Commercial banks allocate capital on the basis of profitability, not social and ecological objectives. The result is that we get massive investment in sectors such as SUVs, fast fashion, industrial animal farming, private jets, and advertising—even though we know they are ecologically destructive and must be reduced—but we suffer critical underinvestment in areas that are clearly necessary for the ecological transition, such as public transit, agroecology, or building retrofits, because they tend to be less profitable.
Remarkably, there is currently no plan for phasing down fossil fuel investments. This is a structural problem, and we need to face up to it. Waiting for capital to speed up decarbonization in line with the Paris Agreement is a strategy that’s doomed to fail.
Fortunately, there’s a straightforward solution. Credit guidance is the key to aligning finance with the aims of the green transition. Central banks have the power to guide credit in more socially and ecologically rational ways. The idea is to limit the quantity of credit that commercial banks and other financial institutions direct to destructive sectors (say, fossil fuels and SUVs) while increasing credit flows to more beneficial sectors (such as renewables and other green technologies).
Credit guidance was used extensively in the post-war period. The policy helped states build up their industrial capacity, expand their welfare systems, and accelerate technological innovation in key sectors where rapid development was needed. It is a central pillar of any successful industrial policy framework. And with the ecological crisis, it is gaining renewed attention: A recent report produced by the University College London’s Institute for Innovation and Public Purpose shows how credit guidance can be used to accelerate an effective green transition.
This approach can also be used to offset inflationary pressure. In a scenario where we need to increase public investment in necessary social projects—such as health care, housing, and transit—credit controls can be used to reduce commercial investments elsewhere in the economy (again, specifically in damaging and unnecessary industries that we need to scale down), thus regulating aggregate demand. This is a much more rational strategy for inflation control than using broad-brush interest-rate policy, which can have a devastating impact on people’s livelihoods and on socially important sectors.
At a time when fighting inflation has become the primary focus of central banks, credit regulations are more pertinent than ever. The inflationary crisis that deepened following Russia’s invasion of Ukraine demonstrated the limits of current tools that central banks use to realize the standard 2 percent inflation target—namely interest-rate policy and the purchase or sale of financial instruments. Mainstream monetary policy is ill equipped to confront what the economist Isabella Weber calls “sellers’ inflation.” Conventional tools failed to pinpoint the price of oil as an inflationary pressure point rippling out across the economy. These instruments are blunt, in that they reduce demand in the economy as a whole without troubling to identify the specific commodities for which demand outstrips supply. Credit regulations, alongside other measures such as price controls, constitute a far more precise instrument for maintaining price stability.
There are many other benefits that a credit-guidance strategy can confer. For instance, it can be used to prevent debt bubbles, by setting conditions to limit lending to financially unstable entities. Had credit guidance along these lines been in place in the United States at the turn of the century, it could have prevented the subprime mortgage crisis.
Some economists balk at the idea of central banks picking winners and losers in the market—even if this is done through democratic processes. Independence remains a core mandate of modern central banks. Nonetheless, the commitment to market neutrality needs to be balanced with other responsibilities. Central banks also perform a macroprudential function in maintaining market stability. Perhaps the greatest threat to stability in the 21st century is the risk of ecological breakdown. Diverting finance away from the sectors responsible for this threat is justified based on established need for “precautionary policy action to prevent the emergence of potentially catastrophic risks.”
The mirage of central bank independence has dissipated since the 1990s. In the aftermath of the European debt crisis and again during the COVID-19 pandemic, the European Central Bank, among others, embarked on massive quantitative easing programs that benefit investors at the expense of savers. Asset purchases on this scale muddy the traditional distinction between monetary and economic policy. Central banks have evolved from institutions narrowly focused on maintaining price stability to ones acting as backstops for the financial system as a whole. Central bank mandates, by contrast, have never been adjusted to reflect this marked change in central bank policy.
If central banks are not in fact as independent and impartial as they seem—if they in fact tend to serve the interests of some at the expense of others—then it makes sense to align them more transparently with democratically ratified social and ecological objectives. The crises of the 21st century call for a reevaluation of the new role played by central banks in an era of fiat currency and high private debt. Rediscovering the power of credit regulations is key both to fulfilling central banks’ macroprudential role and to guiding our economies away from ecological breakdown and instead toward a rapid green transition.
Credit guidance is not a silver bullet, of course. It does not prevent companies—including big oil—from investing their own capital in damaging activities. It cannot substitute other necessary regulations, such as safety and labor standards. And it does not obviate the need for public investment mechanisms to provide necessary services that do not return a profit. But credit guidance does empower us to channel private capital toward the most urgent objectives we must achieve. It should be seen as a necessary complement to what John Maynard Keynes called the socialization of investment.
Industrial policy along these lines is no longer just a nice idea. It has become an existential necessity. We know we need to scale down fossil fuel output on a science-based schedule, while rapidly accelerating renewable energy development alongside other activities that are necessary for a green transition. Credit guidance can help us achieve these goals, and any forward-thinking government should take steps in this direction.
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