Green monetary policy to combat climate change: Theory and evidence of selective credit control

Abstract

Recognizing climate change as a formidable threat to global economic stability, the study underscores the inadequacies of existing fiscal tools, such as carbon taxes and carbon trading, in effectively mitigating carbon emissions and explores the potential impact of climate-related uncertainties on the global financial and monetary system. The paper delineates the necessity of integrating environmental goals into monetary policy frameworks, proposing a Green Monetary Policy (GMP) Framework that explicitly incorporates emission reduction targets into traditional monetary instruments to confront the growing challenges of climate change. Innovating an economic model for the GMP, the paper presents nuanced insights into the potential role of central banks in addressing climate change. The consequent mathematical calibration and findings advocate for a strategic shift in credit allocation from high carbon-intensive activities to low carbon-emitting industries using selective credit control instruments by central banks to combat climate change. Moreover, using Panel VAR and Impulse Response Functions (IRF), the study examines the period spanning 2004–2020 across diverse economies—Brazil, China, the EU, India, and the US. The results suggest that central banks can achieve the dual objectives of maintaining price stability and sustainability by exerting effective control over emissions. In essence, this research lays the foundation for a comprehensive understanding of alternative economic policy tools and strategies available to policymakers in navigating the intricate landscape of climate-related economic challenges.