Monetary Architecture and the Green Transition

Abstract

How to finance the Green Transition towards net-zero carbon emissions remains an open question. The literature either operates within a market-failure paradigm that calls for a Pigou tax to help markets correct themselves, or via war finance analogies that offer a ‘triad’ of state intervention possibilities: taxation, treasury borrowing, and central bank money creation. These frameworks often lack a thorough conceptualisation of endogenous credit money creation, for instance when resorting to loanable funds theory, and disregard the systemic and procedural dimensions of financing the Green Transition. We propose that ‘monetary architecture’, which perceives the monetary and financial system as a constantly evolving and historically specific hierarchical web of interlocking balance sheets, offers a more comprehensive framework to conceptualize the systemic and procedural financing challenges. Using the US as an example, we draw implications of a systemic financing view while considering a division of labor between ‘firefighting’ institutions such as the Federal Reserve and the Treasury, and ‘workhorse’ institutions such as off-balance-sheet fiscal agencies, commercial banks, and shadow banks. We argue further that financing the Green Transition must undergo three ideal-typical phases—initial balance sheet expansion, long-term funding, and possibly final contraction—that require diligent macro-financial management to avoid financial instability.

Towards a public sustainable finance paradigm for the green transition

“…Direct public investments would thus not lead to increased private investment activity, but, by winning the competition over scarce resources, crowd out more risky private investments. Although the loanable funds theory is rarely made explicit today, the sustainable finance discourse is often implicitly based on it (Murau et al, 2023). The idea of Public Sustainable Finance, however, contradicts the logic of the New Consensus Model.…”

“…The funds necessary for investments are created out of nothing at the moment of lending. This means that limited loanable funds simply do not exist and can therefore not be missing or represent an obstacle to investments (Murau et al, 2023). Rather, the opposite is theoretically justifiable and empirically evident: Direct state investments in transformation projects can crowd-in private investments.…”

“…A feasible strategy to implement large-scale public investments despite constrained macro-financial conditions is the usage of OBFAs, which have historically offered financial leeway in the United States (Quinn, 2019;Orian Peer, 2020;Murau et al, 2023), the European Union (Mertens et al, 2021;Guter-Sandu and Murau, 2022), or countries such as Mexico, Canada, Norway, Japan, and China (Mikheeva and Ryan-Collins, 2022).…”

“…On the policy level, Public Sustainable Finance includes a variety of policies that are geared at strengthening state capacity and directing public investments towards the green transition. Importantly, Public Sustainable Finance policies span not only government agencies but also off-balance-sheet fiscal agencies (OBFAs) at different layers of a multilevel governance system (Murau et al, 2023). While the most effective policies may vary across countries, Public Sustainable Finance emphasises the importance of direct public investments into various domains of the green transition, such as infrastructure and energy.…”

Green Macro-Financial Governance in the European Monetary Architecture: Assessing the Capacity to Finance the Net-Zero Transition

“…This approach offers an innovative way to explore the capacity of the European monetary architecture to deliver on the financing challenge of the Green Transition. We address this issue through the prism of a procedural macro-financial governance scheme (Murau, Haas, and Guter-Sandu 2023) which comprises four steps. Accordingly, we assume that financing the Green Transition requires first a large-scale expansion of various public, private, or hybrid balance sheets to create money and provide financing for decarbonisation projects.…”