The ECB’s New Approach: Integrating Environmental Degradation into Monetary Policy

The European Central Bank (ECB) has recently acknowledged the direct impact of environmental degradation on inflation and economic growth. This recognition marks a significant shift in the ECB’s monetary policy, which is now fully influenced by the concept of “degradation of nature.”

Environmental degradation encompasses the entire physical environment of the Earth, including all living organisms and natural resources. The ECB’s decision to incorporate this concept into its monetary strategy is a groundbreaking advancement. For instance, 15% of the euro area’s economic output is vulnerable to water scarcity, and euro area banks have provided over €1.3 trillion in loans to sectors exposed to this risk. By considering environmental degradation, the ECB is demonstrating a commitment to addressing a broader range of factors beyond climate change.

The ECB has identified clear signs that the nature crisis poses significant risks to the economy. Failing to consider these risks may overlook relevant evidence and could affect the goal of maintaining price stability. During the particularly hot summer of 2022, food price inflation increased by between 0.4 and 0.9 percentage points. The ECB is currently studying the impacts of such extreme weather on inflation and GDP to better understand future challenges.

Unlike climate change, which can be measured using various metrics such as greenhouse gas emissions, the degradation of nature is more complex and lacks a single metric like CO2. To understand the nature crisis, it is necessary to have a comprehensive approach and consider factors such as fish stocks, timber, land, scarcity, and water quality.

In its recent review of the Monetary Policy Strategy, the ECB’s Governing Council committed to fully accounting for the implications of climate change and nature degradation within its primary and secondary mandates, in line with its Treaty obligations. The Treaty stipulates that the Eurosystem must support the European Union’s general economic policies, contributing to objectives such as balanced economic growth, a highly competitive social market economy, full employment, social progress, and a high level of environmental protection and improvement.

Conclusions

The ECB’s integration of environmental degradation into its monetary policy represents a forward-thinking approach to addressing the multifaceted challenges posed by the nature crisis. By considering a broader range of environmental factors, the ECB aims to maintain price stability while supporting the EU’s broader economic and environmental objectives. This comprehensive perspective emphasizes the need to acknowledge and address the intrinsic link between environmental health and economic stability.