Green macro-financial governance in the European monetary architecture: Assessing the capacity to finance the net-zero transition

Abstract

The European Green Transition requires massive financing efforts, with estimates of EUR 620bn EUR annually, and the headwinds are substantial. Central banks seem overstretched and busy tightening to combat inflation; treasuries are subject to austerity-inducing fiscal rules; and banking systems are afflicted by non-performing loans, fragmentation, and risk aversion. We employ the Monetary Architecture framework to analyze the EU’s monetary and financial system as a constantly evolving hierarchical web of interlocking balance sheets and study its capacity to find “elasticity space” to meet the financing challenge. To this end, we draw on a four-step scheme for Green macro-financial governance along the financial cycle of balance sheet expansion, funding, and final contraction. We find that, first, Europe’s monetary architecture still has ample elasticity space to provide a green initial expansion due to its developed ecosystem of national, subnational, and supranational off-balance-sheet fiscal agencies. Second, as mechanisms to consciously organize the distribution of long-term debt instruments across different segments are absent, its capacity to provide long-term funding is limited. Third, institutional transformation in the last two decades has greatly improved the capacity of the European monetary architecture to counteract financial instability by providing emergency elasticity. Fourth, the capacity of the European monetary architecture to manage a final contraction of balance sheets is limited, which is a general quandary in modern credit money systems. Our analysis points to the need for further investigations into techniques for monetary architectures to manage long-term funding and balance sheet contractions.