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A monetary policy at the service of European investment and the climate

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In its analysis note "A proposal for financing low-carbon investment in Europe", France Stratégie proposes a carbon-backed financial intermediation mechanism that would enable Europe to give a low-carbon direction to future growth and thus strengthen its historical leadership on climate issues. The study also defines the conditions for overcoming stagnation in Europe and resolving the lack of investment in the energy transition through a targeted policy of asset purchases by the central bank.

The year 2015 will be marked for Europe by a double urgency: that of acting against global warming and that of getting out of the economic slump. Today, these two debates are taking place separately:
- within the strict framework of the climate negotiations which should lead to an agreement at the end of the year in Paris;
- in the context of the European investment plan announced by Jean-Claude Juncker and a policy of asset buybacks by the European Central Bank (ECB) to avoid the deflationary spiral and stimulate a recovery in investment.
This analysis note proposes a common framework for action on these two issues.

The history of international climate negotiations shows that it is very difficult to put a price on carbon. While in theory, the carbon tax and the emission quota system are the best instruments to make people pay the price of the externality induced by each unit of CO2 emitted, in practice, the implementation of climate policy faces, in the short term, strong social opposition from households and businesses, for whom it will result in significant additional costs.
In order to circumvent this opposition and at the same time better smooth efforts while making a credible commitment to the transition, this note proposes to make private securities whose proven low carbon impact has been previously guaranteed by the public authorities eligible for the ECB's asset repurchase policy. Indeed, by limiting itself essentially to the repurchase of securities issued on the secondary market, the ECB risks having only an indirect influence on new investments and thus on the scale and quality of growth. The proposed mechanism, on the contrary, involves financing directed towards new investments, especially low carbon investments, thus ensuring a faster but also more sustainable recovery.
This mechanism would make it possible to give a low-carbon direction to the investment component of the European crisis exit strategy.

The originality of the proposal lies in the joint involvement of public authorities and the private sector to send a signal on a high carbon value from the outset so as to guide new investments in the (temporary) absence of an adequate carbon price. This allows new low-carbon investments to be profitable without immediately penalizing the capital stock. It also has the effect of immediately influencing investment decisions while allowing the carbon price to rise gradually. In addition, States also have a strong incentive to put in place carbon pricing mechanisms so that the guarantee they provide on the value of carbon assets is neutral for the public budget.
This proposal for carbon-based financial intermediation is based on five main principles:

1. Defining a Social Carbon Value (SCC)

It is neither a price that is set in a carbon market nor a tax embedded in the price of everyday commodities. It is a theoretical price defined as the value of a tonne of CO2 equivalent avoided. Available estimates of the VSC indicate a wide range of values that depend on a large number of parameters. It is therefore ultimately up to the government to decide on the level.

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2. Determine a total volume of low-carbon investments whose value is guaranteed by the State.

Each State shall determine its national contribution to the international strategy to reduce carbon emissions by committing itself to ensuring a global amount of investment to meet this national target. The guaranteed value of each low-carbon investment project corresponds to the emissions saved on the basis of the social value of carbon (SVC).

3. Certify emission reductions

An independent body ensures the a posteriori control of the carbon emissions saved by each project. This institution defines a typology of low-carbon projects and methodologies for evaluating emission reductions according to the technologies concerned, the sectors and the time horizons of the projects. In this way, private investors can anticipate the carbon value of their projects and deduct the public guarantee that will be given to them.

4. Record carbon assets on the monetary institution's balance sheet

The central bank undertakes to refinance loans issued by commercial banks to finance low-carbon investments. The central bank guarantee applies up to the value of the emission reductions actually achieved by the projects, as defined by the VSC.

5. Redirecting long-term savings to low-carbon investments

In addition to mobilising the bank credit channel, the monetary mechanism offers a lever to redirect savings towards low-carbon investments. The fact that the central bank agrees to "pay" for emission reductions at its social value provides sufficient guarantee to design, via specialised funds, a range of financial products, such as "green bonds", which are safe and therefore highly rated.
Through taxes and quotas, public authorities manage the gradual rise in the price of carbon in such a way that it remains tolerable for existing carbon-intensive investments but eventually generates sufficient income to honour the public guarantee on carbon certificates.

The mechanism proposed here offers precisely one form of quantitative easing under control (via the carbon metric introduced), which improves the quality of growth. It also strengthens Europe's non-price competitiveness due to the spill-over effects of the transport and energy sectors on the economy as a whole.
Compared to policies that only seek to act on the implementation of a carbon price, with little success so far, the proposed mechanism makes it possible to directly and immediately mobilise the leverage of bank credit and savings for the energy transition.
The European Union should promote a monetary policy at the service of European investment and the climate, to give a low carbon direction to future growth and thus strengthen its historic leadership on climate issues. Europe's influence vis-à-vis emerging countries at the Paris conference in December 2015 will largely depend on its ability to demonstrate that solutions exist to reconcile sustainable prosperity and ambitious climate objectives.

Summary :
- Europe in 2015, facing the challenges of climate and growth
- The difficult emergence of a carbon price
- Financial intermediation to invest in the low-carbon transition
- A monetary plan to finance the low-carbon transition

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Authors Michel Aglietta, scientific advisor at the CEPII and France Stratégie; Étienne Espagne, project manager at the Économie-Finances department, France Stratégie; Baptiste Perrissin Fabert, project manager for "climate economics" at the General Commission for Sustainable Development, Ministry of Ecology, Sustainable Development and Energy.

Download the analysis note "A proposal for financing low-carbon investment in Europe".

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