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The challenge for central banks will be to reconcile their narrow monetary policy objectives with maintaining relatively low yields for markets to fund large public and private sector financing requirements.
Net zero: an unprecedented financing dilemma
The green transition presents an unprecedented financing dilemma.
The long-term financing requirement for countries to meet the net zero transition will require very large annual outlays, with the private sector taking on the lion’s share if these ambitious targets are to be met. With public debt also at unprecedented levels in most advanced countries – following unusually large fiscal outlays to deal with recent shocks – it is difficult to see how governments could consider contributing any sizeable amounts.
Fiscal constraints and the role of the private sector
Fiscal space in most countries is an important constraint, particularly in the face of the other demands governments are facing – higher defence expenditure and addressing the impact of higher inflation on low-income segments of their populations.
Private financing of the green transition will also face challenges. Investment in green energy will require incentives in the form of higher expected returns than investments in old energy. Governments can, and will need to, incentivise private investment through changes in relative prices that make old energy more expensive, primarily through higher carbon taxes (see article Five questions on the impact of carbon taxes on economies and markets), and other incentives, such as the Inflation Reduction Act in the United States.
Central banks pivotal in keeping price stability
Regardless of the relative contributions of the public and private sectors, the aggregate demand for climate investment will be high and will extend over a long period. Climate experts estimate that the annual global demand for climate investment will be in the order of USD 4-5 trillion from 2030 to 2050. If the world manages to get to net zero by around 2050, markets will need to provide this funding at yields that are consistent with expected returns. This is a tall challenge. It almost certainly means that macroeconomic policy, including central bank actions, will need to ensure conducive financial conditions.
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