Joeri de Wilde: Fed independence already compromised
This column was originally written in Dutch. This is an English translation.
By Joeri de Wilde, Investment Strategist at Triodos Investment Management
By pulling out of the Network for Greening the Financial System, the Federal Reserve probably wants to get a whitewash from Donald Trump. This shows that the bank could just bow out even in the face of political pressure on interest rate policy.
In my column last month, I discussed the exodus of the largest US financial institution from global climate alliances, prompted by Trump's election victory. Sustainability ambitions announced with much fanfare were just as easily watered down when the political winds changed. The loss of credibility proved outweighed by potential political backlash.
If there is one institution to which this should not apply, it is a central bank. After all, trust in it is based on its perceived political independence. This trust is an important prerequisite for successful monetary policy and a minimum level of calm in financial markets.
It is therefore highly remarkable that the Federal Reserve recently joined the pragmatic and Trump-fearing party. The US central bank exited the Network for Greening the Financial System (NGFS), which it had joined only four years ago.
The NGFS is an international partnership of central banks and regulators to green the financial system and increase the financial sector's efforts to meet the Paris climate goals.
Unjustified hiding behind mandate
That political pressure led to the Fed's decision is clear from the reason given for the departure. When the Fed joined the NGFS, it wanted to ‘increase its understanding of the impact of climate change on the financial system. According to the Fed, the work of the NGFS has since expanded to such an extent that many issues now fall outside the Fed's legal mandate.
Indeed, the NGFS has broadened its scope by also looking at other ‘nature-related’ financial risks, such as biodiversity loss. This in itself is useful knowledge that can help ensure financial stability, but even if the Fed were willing or allowed to focus only on climate change, these risks are highly relevant. Understanding such themes is exactly why the Fed joined, in its own words, four years ago.
The NGFS has also recently been looking more at macroeconomic impacts of climate change, with an explicit focus on employment. Given that the Fed is one of the few central banks that has maximum employment in its mandate in addition to price stability, the network thus seems to have only become more relevant in this regard as well. That the Fed will not make more use of this knowledge is worrisome. It increases the likelihood of mishaps within the US, and thus global, financial system through misjudging risks.
Political headwinds appear to be real reason
In the short term, the departure exposes an even bigger problem: Fed chairman Jerome Powell appears sensitive to political pressure. Just a few months ago, he explicitly stressed that the Fed is and remains independent, saying that the president has no legal authority to fire Fed members. He even suggested he would enter a legal battle if Trump did try to gain influence via that route.
The political independence of Western central banks has been the pillar on which financial markets' confidence in the monetary system has been built for decades. Once investors start doubting this independence, chaos in the markets is not far away. So far, it seems that investors do not see the departure from the NGFS as a sign of Powell's weak knees. But what if Trump steps up the pressure soon and demands lower interest rates, for instance?