The monetary policy of ‘leaning against the wind’ involves a higher policy interest rate. It is usually justified as reducing the probability and severity of a future crisis. This column argues that the costs of the policy exceed the benefits by a substantial margin, especially when taking into account that the cost of a crisis is higher if the economy is initially weaker due to the leaning itself. Furthermore, contrary to the common argument that the policy may be justified when macroprudential policy is less effective or even non-existent, less effective macroprudential policy actually makes the case against leaning against the wind policy stronger, not weaker.
Lars E.O. Svensson, 12 January 2016
Stefano Giglio, Matteo Maggiori, Johannes Stroebel, Andreas Weber, 29 November 2015
The optimal investment to mitigate climate change crucially depends on the discount rate used to evaluate the investment’s uncertain future benefits. The appropriate discount rate is a function of the horizon over which these benefits accrue and the riskiness of the investment. In this paper, we estimate the term structure of discount rates for an important risky asset class, real estate, up to the very long horizons relevant for investments in climate change abatement. We show that this term structure is steeply downward-sloping, reaching 2.6% at horizons beyond 100 years. We explore the implications of these new data within both a general asset pricing framework that decomposes risks and returns by horizon and a structural model calibrated to match a variety of asset classes. Our analysis demonstrates that applying average rates of return that are observed for traded assets to investments in climate change abatement is misleading.
Richard S J Tol, 25 April 2014
The IPCC’s Fifth Assessment Report estimates lower costs of climate change and higher costs of abatement than the Stern Review. However, current UN negotiations focus on stabilising atmospheric concentrations of greenhouse gases at even lower levels than recommended by Stern. This column argues that, given realistic estimates of the rate at which people discount the future, the UN’s target is probably too stringent. Moreover, since real-world climate policy is far from the ideal of a uniform carbon price, the costs of emission reduction are likely to be much higher than the IPCC’s estimates.