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The EU’s reaction to the current inflationary episode shows that it still follows a macroeconomic paradigm that makes it unable to properly react to the climate crisis and will ultimately lead to economic and ecological misery.

A quick recap: We had a massive pandemic but thanks to government intervention demand stayed high. However, changed spending patterns and rolling production shutdowns led to significant supply chain disruptions. Then came Russia’s invasion with an accompanying shock to energy and food supply.

In short, supply was down while demand stayed the same. Thus, prices rose and the European Central Bank (ECB) felt it had to intervene with an unprecedented series of rate hikes.

The ECB had to push down demand towards the subdued level of supply to realign prices. Given its singular focus on price stability, the ECB probably felt like it did not really have much of a choice.

It’s unclear how much of the decreasing inflation numbers is due to the ECB policy and how much is due to lower energy prices and other product prices as firms and governments got their supply chain problems under control.

What is clear, however, is that demand was pushed down. The figure below shows how net bank lending to firms plummeted at the end of last year.

The chart shows exactly what central bankers focused on price stability would like to see, and it shows exactly what we do not want to see from the perspective of a fast green transition. Less bank loans to firms mean less investment, which means a slower green transition.

As banks become more cautious about lending money, they also change who they are lending to. As the figure below shows, bank lending to young and small firms plummeted disproportionately after the ECB’s rate hike.

This figure is devastating for a market-based system that wants to achieve its green transition not through government-mandated shrinking and draconian environmental regulations, but through innovation.

There’s no better way to innovate ourselves towards the green transition than by funding young companies with fresh ideas and technologies. Alas, that’s not going to happen.

The technological innovation approach to solving the climate crisis will fall victim to the singular focus of monetary policy on price stability.

“Aren’t you exaggerating?” you might ask. After all, this has been a special situation and after one or two years of subdued demand to calm prices, investments will be able to pick up again, right?

There are two problems with this line of thinking.

First, as the chart of the week below shows, one or two years is a long time when we are in a race for survival and temperatures are rising faster than we were expecting.

Second, the climate emergency will in all likelihood bring new supply shocks.

Heat waves will devastate crops to increase food prices, floods will destroy production facilities to increase manufacturing prices, water scarcity could lead to temporary shutdowns of nuclear and hydropower increasing energy prices, and then there are new epidemics or wars that could break out to seriously shake up our supply chains again.

Under the current paradigm, the central bank’s answer to each of these supply shocks will have to be to lower demand and suppress investment in the medium term.

Moreover, a more active industrial policy that the EU seems to want will automatically lead to some inefficiencies. First, to make the EU economy more resilient to supply shocks will require the build-up of some reserves and redundancies that come with higher costs and prices.

Second, as we do not know exactly what the future will look like, money will have to be invested in a lot of different technologies. Some of those will prove useless or impractical.

This means that some of the money will be “wasted”, increasing demand while not increasing supply through increased productivity, thus leading to inflationary pressure.

If the ECB has to counteract this by making credit more expensive, the industrial policy and the green transition as such will become more expensive, slower, and politically more toxic.

Monetary policy is wired in a way that that will make it lower demand rather than help increasing supply. This is similar to the EU’s approach to fiscal policy (which I criticised in a recent Economy Brief).

The EU fiscal rules counterproductively try to reduce the debt burden by constraining spending instead of by boosting the economy through investments. The EU’s economic governance set-up considers money and its scarcity as the economy’s most binding constraint.

If the EU wants to tackle the environmental challenge for real, it will have to bin this assumption.

Money is not scarce, the planet is.

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European Employment & Social Rights Forum (16-17 November 2023)

Chart of the week

Byebye Paris.

This past September was the first month in which monthly global average surface temperature clearly exceeded the 1.5 degrees limit that the Paris Agreement set as an upper limit for the acceptable temperature increase compared to the pre-industrial average.

Already July and August this year were the hottest months on record. While they scratched the 1.5 degrees limit, September smashed the barrier with a global average temperature that was 1.752 degrees higher than the pre-industrial average for September.

We collectively raced through a speed control, pushing the pedal to the metal while showing the police the finger. Of course, there is no police, just our future. While it is certain to catch us one day, it cannot point any guns at us right now. So we speed on.

Today’s chart of the week shows how the average global September temperature slowly edged higher over the past thirty years, and how it then took a big leap this year.

It looks quite bad, really.

You can find all previous editions of the Economy Brief Chart of the week here.

Economic Policy Roundup

European Parliament agrees negotiating mandate on forced labour products ban. On Monday (16 October), EU lawmakers of the internal market and international trade committees adopted their position on the proposed ban on products made with forced labour from the EU market. The report supports a stronger role for the EU Commission during investigations, remediation for victims of forced labour and a reversal of the burden of proof for products from high-risk areas. EU lawmakers also agreed to proceed directly to interinstitutional negotiations, without a plenary vote. However, member states have yet to agree on their position on the proposed regulation.

Parliament agrees position on STEP fund. The European Parliament voted in plenary in favour of a negotiating mandate for a new Strategic Technologies in Europe Platform (STEP) on Tuesday (17 October) but they also warned this must only be a first step towards a full-fledged sovereignty fund. In contrast to the Commission’s proposal, the Parliament wants to align definitions with the Net-Zero Industry Act an the Critical Raw Materials Act, and it also wants it to have €3 billion more at its disposal for a total of €13 billion. Read more.

EU finance ministers delay EU fiscal rules decision. Meeting in Luxembourg on Tuesday (17 October), finance ministers did not reach an agreement on the reform of fiscal rules. The next goal is to agree on the most important things at their November meeting in Brussels to finalise the new rules before the end of the year. The ministers and the Commission currently refuse to speculate on the alternative scenario in case they cannot agree on new fiscal rules.

European Parliament calls for bigger 2024 EU budget. On Wednesday (18 October), EU lawmakers adopted their position on the EU budget for 2024, reversing cuts made by member states to the original Commission’s proposal. Following the vote, the institutions have three weeks to find a compromise.

Slow progress on due diligence discussions. Member states have not reached any agreement on the inclusion of finance under the proposed EU corporate accountability rules following a meeting early this week. The inclusion of finance is one of the key points in the ongoing negotiations on the file, but member states remain divided on the issue. Another meeting is foreseen next week, while the next negotiation round with the Parliament is set to take place in November.

ECB starts “preparation phase” of the Digital Euro. On Wednesday (18 October), the ECB’s governing council decided that it would launch the preparation phase of the digital euro after a two-year investigation phase. In this preparation phase the ECB wants to finalise the rulebook and start selecting providers to develop the infrastructure. However, this decision is not yet a decision on whether the digital euro will be implemented or not.

German industries push for subsidies ahead of government meeting. Ahead of a meeting of leaders of German government parties on Friday (20 October), representatives of energy-intensive industries have urged the government to decide on subsidies for electricity prices. While the debate on a subsidised electricity price for certain industries “has been going on for months without any results,” “the massive cutbacks in local production that can already be observed are acutely endangering jobs and locations,” the representatives of the steel, paper, chemical and glass industries, as well as trade unions, write. However, economists overwhelmingly oppose the idea of subsidising electricity prices for certain companies, which could increase electricity prices for other consumers.

Green investors warn EU against rollback of climate policies. Despite the transition to climate neutrality creating frictions in the short-term, politicians should not change course, investors in green technologies said, asking for clear signals that the transition will be followed through. Read more.

Literature corner

EU Cohesion policy: The cash dispenser that needs repair.

How the US and EU can snatch climate-trade victory from the jaws of defeat.

Additional reporting by Silvia Ellena, Théo Bourgery-Gonse, Jonathan Packroff.

[Edited by Zoran Radosavljevic]

Read more with Euractiv

Green investors warn EU against rollback of climate policies

Despite the transition to climate neutrality creating frictions in the short-term, politicians should not change course, investors in green technologies said, asking for clear signals that the transition will be followed through.