ECONOMIC CONFERENCE 2022. SUMMARY
The themes covered at the economic conference marking the centenary of Latvijas Banka and held on 3 November were equally reflecting the everyday life of the users of money as well as the agenda of central banks, financial supervisors and central government budget planners:
- the high euro area inflation which needs to be swiftly contained in a coordinated manner, inter alia, by raising the policy rates or the price of borrowing;
- the movement towards truly green economy requiring a multi-faceted understanding of sustainability risks, going beyond climate change. This time the discussion was centred around biodiversity risks, something more complicated and less researched. And also the role of central banks in identification and prevention of environmental risks;
- the potential future and application of a digital euro, as the technologies have enabled the creation of digital central bank banknotes and coins.
On that particular day, Riga undertook the role of a "European financial centre" in a way. Top financial decision makers of the euro area and the European Commission, European central bankers, one of the global network platform companies and distinguished economics theoreticians analysed nuances of how to adopt good quality decisions that would stand for the next hundred years to come in the respective subject fields.
The conference "Sustainability and Money: Shaping the Economy of the Future" was held in the period marking the centenary of Latvijas Banka which was established during the young days of the Republic of Latvia. When opening the conference, the President of the Republic of Latvia Egils Levits stressed the bank's role as the centre of the national financial system and an important contributor to the national stability. It is strengthened by the independence granted to the central bank which needs to be cherished also in the future. He outlined the immediate challenges to be faced by this generation, inter alia, mentioning that the banking sector should actively engage in the green transition to sustainable economy, particularly in the energy sector.
The audience that packed Ziedonis Hall of the Latvian National Library and online viewers could gain an insight and make conclusions as to what awaits every euro user in the coming months as well as the next couple of years. Further interest rate hikes must follow in autumn 2022 to reign in the soaring inflation primarily fuelled by the war in Europe and the fallout from the pandemic.
Introductory panel: A Bridge over Troubled Waters
The conclusion of the euro area monetary policy makers and the financial decision makers of the European Commission in relation to the euro was that the soaring inflation which is basically fuelled by the energy prices rising as a consequence of the war and their pass-through must be swiftly contained in a coordinated manner. The message from President of the ECB Christine Lagarde: The ECB has already raised the interest rates and will continue with further hikes until it secures a return to its low inflation target.
That is not going to make fuel cheaper, but we will contain the core inflation which is not affected by energy and food. The ECB remains fully resolute to apply all its monetary instruments to implement the ECB's strategy renewed in 2021 and containing a symmetric commitment to the inflation target of 2% in the medium term. Although recession is currently not the ECB's baseline scenario, it would be insufficient to dampen the inflation anyway; therefore, the rates must go up.
One drummer is not a rock band!
An agreement on policy coordination and the split of the tasks to be addressed by budget makers, central banks and structural policies (in energy, education, labour market) is also required. Counteraction or one player undertaking to accomplish too much in relation to inflation just results in additional problems for the economy. During the previous crisis, central banks have often been almost the only fighters.
Even a rock band can never rely on just a drums solo, all instruments must play to have a full sound, was a comparison made by Mārtiņš Kazāks, Governor of Latvijas Banka and Member of the ECB's Governing Council and General Council. The history has also taught us to deal with inflation in the first go, otherwise the problem only gets bigger with each next one, like Godzilla in Hollywood remakes. "The rates must still go up considerably, no need to pause next year, until the desired outcome is achieved," highlighted the Governor.
Europe's support to Ukraine – until the victory
Clear support to Ukraine until its full victory in the fight against the aggression turning into a global battle of values was voiced, sanctions against Russia and support to Ukraine must continue. Ukraine must win, just like Latvia won its victory in the War of Independence!
Valdis Dombrovskis, Executive Vice President of the European Commission said that we still have to get to "Marshall plan" for Ukraine. (The World Bank has estimated the damage at USD 400 billion when calculating the aggressor's reparations). Currently, we are looking at short term. Ukraine will receive EUR 18 billion from Europe in 2023 for daily needs. Ukraine has also asked for a greater degree of predictability in EU support, and that will be granted.
The Green Deal addresses also the inflation problem
The transition to sustainable economy that has already started in Europe should also be used to contain the inflation, and we should stop sawing off the environment and climate branch on which the humanity is sitting. There should be no pause in implementing the Green Deal of he European Commission's policy, as Mother Nature cannot wait. Climate change is also incorporated in central bank analysis, it affects their decisions because of the effect on various economic fundamentals, including inflation.
Financial discipline is still there, the Stability Pact and its triggering mechanism are still effective, the EC recommends caution in public finances after the ample support provided during the pandemic, public support to businesses and the most vulnerable population groups should be temporary, targeted and contain energy consumption reduction incentives.
The Green Deal is becoming part of the current crisis management and supplements the substitution of Russia's energy resources and phasing out fossil fuels, stressed Valdis Dombrovskis. Independence of the energy sector and increased use of renewables will also help to reduce inflation. Latvia should also work on substitution of gas supplies from Russia and continue building up the base of renewables where we are already among the European leaders.
Public financing is important to deliver the Green Deal, but the bulk should come from the private sector. "That's, indeed, where our sustainable finance agenda comes in, how to steer also private investments towards those sustainability goals", said Valdis Dombrovskis.
Panel discussion I: Shadowed by Carbon
Transition to a truly green economy, requiring a multi-faceted understanding of sustainability risks without merely focussing on climate change, has made us concentrate on the more complex and less researched biodiversity risks this time. The role of central banks in identification and prevention of environmental risks. As to the financing required for the transition to a sustainable economy, the most important issue is how to mitigate impediments with the help of banking supervision and other tools by a more accurate evaluation and mitigation of biodiversity and other environmental risks. This is an area where the financial sector itself, just like the public sector and businesses, still has to look for the answers.
Gretchen C. Daily, Professor of Environmental Science at Stanford University, began with an introductory theme worthy of Beethoven's fate motif. Humanity is driving a new sixth mass extinction as we are losing the biodiversity faster than ever. Civilisation came along at a time of a great climate stability, and we are so deeply embedded in biosphere, dependent on it in countless ways where pollinators are just one example and their destruction would be a suicidal path.
What can be done? Many things provided to us by the stewards of the biosphere remain outside regular observation and evaluation. This should be revealed more visibly, integrated in policy making and economic decisions, including the financial system. It's starting to happen, but we are just at the beginning. We should, in a sense, become the science civilisation, cooperating more and reviving the understanding of the place of nature in our lives and respecting the inter-dependency of various societies.
After the Great Depression when we acknowledged that we had been flying blind and the gross product metric was created, now the metrics for biodiversity, natural value are being developed. The UN offered a gross ecosytem product metric in 2021 for all goods and services derived from nature. It helps in planning financial flows, supporting regeneration of nature and tracking progress. This metric still has to be fine-tuned though.
Do we need one metric for everything or many specific ones? There is a place for each, like blood pressure for health, but a specific diagnosis will require many others. Like a specific country needs many indicators, a micro level assessment of the impact on local ecosystems is required. Currently, already 185 countries have taken up the modelling approaches. The models are developed under the auspices of the UN climate panel IPCC to locally and regionally quantify natural values. China having experience in environmental transformation with grave consequences is also involved.
Frank Elderson, Member of the ECB's Executive Board, co-chair of the Task Force on Climate-related Financial Risks of the Basel Committee on Banking Supervision highlighted why central banks should care about the issues concerning biodiversity and climate change consequences and integrate them into monetary policy and banking supervision decisions. If we don't act, we wouldn't be fulfilling our mandate. There can be always the question whether things are happening quickly and effectively enough.
We are public political decision makers translating those issues in our mandates in monetary policy and banking supervision. It also means integrating the natural values in policy making and green transformation of businesses now. Central banks and banking supervisors in more than 120 countries are asking increasingly more detailed questions to commercial banks as to their exposures to climate and loss of biodiversity risks. These central bank practices are here to stay.
The ECB's Banking Supervision developed climate and environment monitoring guidelines in 2021, and the self-assessment required from banks concluded that there is still a lot to do. Supervisors have also conducted their own checks and we see that the glass is not even half full. The banks have until 2024 to ensure compliance, with some interim results to be produced. We try to help them, advising the banks on best practices without mentioning specific brands.
François Villeroy de Galhau, Governor of Banque de France, highlighted the practical accomplishments in the area and stressed the need to also integrate biodiversity in the future monetary policy considerations. For comparison, just a few years ago central banks and the financial system alike did not realise their roles in preventing climate change and preserving biodiversity. Now we are taking an immediate action, step by step, pragmatically starting with climate change, then biodiversity and after that other climate related aspects. There is hope that we will be able to ensure a holistic approach, unlike the previous US Administration which ignored climate change.
We must admit that we lack information on one causal chain between the loss of biodiversity and economic developments. But just because we do not know specific data and are not fully sure about the metrics, it does not mean that we can do nothing, just on the contrary! We acknowledge the value of biodiversity now through so-called ecosystem services, highlighting 18 categories, for example, climate regulation. More than half of the global GDP or USD 44 trillion of economic value generation depend on them.
Two positive examples of new metrics created in cooperation that help greening businesses and finance practices. First joint effort – Dutch methodology and French implementation – The Global Biodiversity Score (GBS) which is a tool for estimating the biodiversity print of businesses. Such aggregated method is not a silver bullet, but it helps to compare various thermometer readings, says the Governor.
The second example is the financial system study on loss of biodiversity caused risks, conducted by the central bank. It is an attempt to use the French example to disentangle the physical and economic transition risks.
One of the conclusions: 42% of securities in the portfolios of French financial institutions have been issued by companies that display a high or very high dependency on at least one ecosystem service. The biodiversity footprint of those securities is comparable to a loss of an undisturbed natural territory corresponding to full "artificialisation" of 24% of the surface area of France. This territory would be twice as big as Latvia. The climate risks of financial institutions are now published, and the process is harmonised.
We have lived for centuries when the economy was disembedded from nature, now it's time to reimbed. We should return to, as the French say, art de vivre. We must return to a harmonious combination between the human activity and nature which has been forgotten, François Villeroy de Galhau concluded on a hopeful note.
Panel Discussion II: Future of Money
The final chord of the conference, which seemed a distant future just a little while ago and has now been enabled by technologies, was the digital euro: what should be the purpose of the central bank digital banknotes and coins alongside euro cash. What should be the form of the digital euro? And maybe we can do without it?
Contrary to the unanimity observed on the previous panels, opinions differed. The ECB and the field's pioneer, Sveriges Riksbank, held the opinion that at a time when the world is becoming increasingly digitalised, central banks must get involved. A distinguished professor of economics and representative of one of the leading global technology companies Google slightly doubted the new value added of a digital euro or krona.
If we don't get involved, we are risking that another supplier better satisfying the public demand for a safe and effective means of settlement and store of value will overtake the money system, said Stefan Ingves, Governor of Sveriges Riksbank. And when that happens, any monetary policy becomes a fiction because you no longer control your currency. The ECB intends to conclude its research phase for the digital euro next October with a decision (if it decides to go for it) as to what the digital euro should be like, reminded President Christine Lagarde.
The same as the central bank cash serves as a reference point for the monetary system, this should be also true of a digital form – it should be an anchor for the system and a monetary policy implementation tool. The ECB's President highlighted that innovations could enable the private sector to take over a larger share of the payment market, but the central bank money must not lose its role in this process.
A central bank steered money enables softening economic volatility and avoiding excessive falls and rises, and the general public must not lose the ability to determine monetary policy also in an era of innovative private digital payment means.
Barry Eichengreen, Professor of Economics and Professor of Political Science at University of California, agreed that the central bank digital currencies are obviously more viable than crypto-currencies or crypto-assets, but also doubted if they have a task that cannot already be addressed today in a different way.
The variety of payment means today can be explained by the technological development that has enabled to divide apart the traditional functions of money (unit of settlement, payment means, store of value) that, until recently, was a natural central bank or state monopoly. When technologies have made migration between payment means cheaper, such opportunities will continue rising.
Nevertheless, we do not wish to return to the US Wild West situation where each private bank was issuing slightly different value dollars. Nearly half a century went by until the issuance of money was entrusted to a federal central bank system which has equal value everywhere. Most of the pro's for having central bank digital money, however, do not really "fly": financial inclusion can be achieved with more direct means, local payment prices are already falling due to the growing fintech competition, yet there is not much hope of a cross-border acceptance because then China and the USA would have to agree on using the same blockchain. Plus the risks of hackers and digital terrorists. China's digital renminbi reminds us of confidentiality issues, as a digital money inevitably leaves trace.
Florence Diss, Head of Google Ready to Pay Partnerships, advised central banks, when thinking about their digital money, not to worry about the former Facebook, now Meta idea of private global money, but focus more on the function that a digital euro or krona could fulfil. If not anything else, simplify currently still complex cross-border payments in Europe. That would clearly be appreciated by the private sector.
A successful money is not only a means of payment, but also a good monetary system management. That's the central bank monopoly, and the private sector has no desire or plans to overtake that, at least now. The Professor and the central bank Governor also agreed that the management of the monetary system cannot be fully automated in the future and would still need a human mind. Most likely we will not see an AI managed central bank also in the future. But the private sector might have some ways of improving also the monetary system management by helping to identify economic development trends quicker and make the right decisions in a more timely manner.
Sweden, where money users and businesses have almost entirely switched to non-cash (electronic) payments over the last decade, is convinced that a central bank retail money does have a function alongside the already available various types of electronic money for large transactions. Stephan Ingves said that a central bank digital currency will have its users and there can be a successful technical solution. It will be created. It will be used by a small part of the population, like it is already happening in Sweden with cash, but it will be used as the preferences differ –some want to store private money, some want to store the one created by the public sector.