How should a central bank respond to energy shocks? Will high oil and gas prices bolster the uptake of renewables? And what is the true cost of net zero 2050?
This week on Cleaning Up, host Michael Liebreich sits down with Pierre Wunsch, Governor of the National Bank of Belgium and member of the European Central Bank’s governing council, for a candid, behind-the-scenes discussion about how central banks should and can respond to inflation, energy volatility, and climate transition.
From the recent surge in oil and gas prices to the lessons learned from post-COVID inflation, Wunsch explains why central banks may have “got it wrong” during the Russia-Ukraine energy shock, and how they’re rethinking their response to supply shocks.
Michael and Pierre dive into:
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PW
It's a bit weird because in a way, if we think about the previous episodes of high inflation, they were coming from energy shocks, and we had to intervene after the oil shocks in the 70s and 80s. But in the meanwhile, we had this kind of new consensus. If it's a supply shock, so it doesn't come from the economy overheating, but a sort of external shock coming from the energy sector, you should not react, or at least you should wait before reacting.
That was seen as transitory, and what happened is that inflation went from 2 to 3 to 4 to 10. And now I guess the inclination is to be more open to the idea that we would have to react at some point. So if this lasts and we start seeing that the impact on energy prices and in our models on inflation is going to be significant, that we should probably react at some stage.
ML
Hello, I'm Michael Liebreich, and this is Cleaning Up. If the events of the last month in the Gulf have taught us nothing else, it is that we live in a world of extreme energy price volatility. Amazingly, there are still those who would claim that that volatility is driven by the transition, by clean energy. There are, of course, on the other side, those who point the finger fairly squarely and only at fossil fuels. Maybe the truth is halfway between them.
But the debate about the macroeconomic impact of energy price volatility and the transition can resemble more a punch and judy show than any sort of rational discussion. One side says that climate change has put us on track to an inevitable financial collapse and that the role of central banks is primarily to try to avoid that. The other side says that any action by central banks on anything related to climate will plunge the world economy into recession and disaster.
My guest today leads an organisation that lies at the very heart of this conversation. He is the governor of one of Europe's central banks. He sits on the governing council of the European Central Bank, and he's a member of the board of governors of the International Monetary Fund. Please welcome Pierre Wunsch, governor of the National Bank of Belgium, to Cleaning Up.
ML
Governor, Pierre, thank you very much for spending time with us here. I can't say joining us because I'm joining you. Here we are in your office, in your studio at the National Bank of Belgium.
PW
Yes, thank you. I mean, it's a pleasure, but I would say it's a honour as well, because I've been told you're a star. So, I'm reaching for the stars.
ML
Very good. Well, thank you. You're very kind. Let's start where we always start, with, in your own words, who you are and also what the National Bank does, but the short version.
PW
The short version. So, I'm the governor of the National Bank of Belgium. We are part of the euro system. So, we set monetary policy at the European level, mostly, I mean, euro zone level, some countries are not in. So, it means that every six weeks I meet in Frankfurt and I'm actually going there tomorrow to discuss monetary policy. So, we have six permanent members and then all the governors of the national banks and we decide on monetary policy.
That's the most visible and important and say international part of my job. But beyond that, we are responsible as well for a bank and insurance supervision and financial stability, but again, in cooperation with the European level for payments, cash, but also some other forms of payments. And then, of course, most central banks, it's our case as well. We have a significant number of researchers, people working on data. We have a big data department as well. We do the national accounts and we do a lot of analysis for the Belgian and European economy, but mostly Belgian.
ML
And I've been really looking forward to this because I can kind of, as a micro economist, I'm pretty good. Basically, I've been in business a lot and I've done lots of analysis and so on. But my macro is pretty weak. I mean, I'm not a trained economist, unlike yourself. You have a PhD. And so, I'm in the presence of greatness on economic thought here. So, I'm quite – I'm a bit intimidated.
PW
Well my PhD was in micro, but I've been doing more macro afterwards. My PhD was on regulation of public monopolies and production frontiers estimates and things like that.
ML
OK. Well, there I would feel on comfortable ground. But the other reason I'm excited is because the piece you haven't mentioned is the stability. And of course, when you talk about the climate and the transition and so on, then there's certainly a lot of people sort of promoting a narrative of collapse, instability, which is one of your formal responsibilities as the national bank to guard against financial collapse.
PW
Indeed. So, we work on that at the Belgian level, but mostly we work with the European Central Bank on financial stability at European level, but also international level. I'm a board member of the BIS where we look at financial stability issues. So, we can certainly come back to that one.
ML
We will get onto, obviously, all of the climate issues. But because of what's happening as we record this, I want to talk about inflation. And I want to talk about, obviously, we've got the situation with the Strait of Hormuz, the US-Israeli attack on Iran. Now, when this episode goes out, it will be – we're recording this on the 16th of March. I should clarify for the audience. So, it could be that everything is either over or has got much worse.
We don't know. But already, what you've got is a clear spike in the price of both oil and gas. And my suspicion is that spike will not have suddenly unwound by the time this episode comes out. So, I'm just interested – this is my opportunity to get behind the curtain and ask, how do you – what happens when there is a sudden commodity price spike when you are running a national bank? I've never been able to ask anybody that yet.
PW
Well, we have to look at it. No, no. It's, of course, it's the X billion question. So, the best way to look at it is come back to the previous crisis where we had COVID and then the Ukrainian crisis with a spike in energy prices, but also a lot of fiscal support being in the pipeline. And the consensus then in literature, but also at the level of central banks, was if it's a pure supply shock, energy shock, you look through. It's going to have an impact on the prices on a temporary basis, deemed transitory, you remember.
And then prices will go down. So, typically, you should not react to that. It's a bit weird because in a way, if we think about the previous episodes of high inflation, they were coming from energy shocks and we had to intervene after the oil shocks in the 70s and 80s. But in the meanwhile, we had this kind of new consensus. If it's a supply shock, so it doesn't come from the economy overheating, but a sort of external shock coming from the energy sector, you should not react or at least you should wait before reacting. That was stream transitory.
And what happened is that inflation went from two to three to four to 10. And now I guess the inclination is to be more open to the idea that we would have to react at some point. So, if this lasts and we start seeing that the impact on energy prices and in our models on inflation is going to be significant, that we should probably react at some stage. So, there is a sort of revisiting of what happened very recently. We got it wrong. It was deemed transitory. And now we are much more cautious. And you will hear central bankers saying, you know, in the literature, we would do this, but maybe we're going to do something different. Well, that's interesting.
ML
So, I love it when people say, well, sort of something works in theory, but not in practise.
PW
There are many of those.
ML
The theory is the thing that's wrong, not the practise. But it's very interesting that you draw the analogy back to the price spike coming out of COVID and when Russia invaded Ukraine, because logically, a short term spike, it ought to work its way through the system. But I think that the communication from, I don't want to say you, but maybe some of your colleagues or maybe certainly, you know, looking around the world… the communication that this would work its way through and should not drive, for instance, increases in pay demands was, I think, not well communicated. So, it did immediately translate into pay demands rather than saying, OK, well, the government's responses, the fiscal response was not, well, we've got a short term problem. We'll put a thousand pounds or a thousand euros into people's, you know, pockets short term to cover a short term spike. Immediately, the discourse was around inflation and everybody was remembering the 1970s and 1980s. And I'm not surprised that it ended with having to raise the interest rates.
PW
Well, the narrative was more like it's going to be transitory, precisely what you said. But what we missed is that it lasted long enough and it was combined with all these fiscal supports, IRA and so on in the pipeline that it led to inflation in goods and services. And then at some point, you had to, you had higher wage demands, not to compensate for the energy shock, which had abated in the meantime, but for the other price increases.
So, you had all the prices going up at some point. And that's what we missed because we thought it would be just a one-off crisis. Energy prices would go up and then down and that it would be the end of the story. But in the meantime, we had, and it's not because wages reacted fast, actually reacted much more slowly than they did in the 70s and 80s, where wages were mostly indexed to inflation.
ML
So, if by the time this episode comes out, the oil price is back down to 60 and the gas price is back down to in Europe, whatever it is, 30 euros per megawatt hour, then this conversation becomes a historical curiosity. And that would be a great outcome and wonderful. But how long, if they stay, or even if they go up higher, how long before you start to get on the phone or you start to have special meetings of the governing board?
PW
We have meetings every six weeks. And so, we are going certainly to discuss the issue. And, you know, if it would last for another one or two months, then we might be in a situation where hiking becomes a possibility, hiking rates.
But maybe to come back to the issue, because we'll talk about the narrative on climate, but I find it interesting that, and basically we see it now, when oil prices go up 20%, people get nervous. When they go up 50%, same for gas, they become very nervous. But the narrative on climate has been, and you know what, if we are forced to stop using gas and oil, it's going to be a great opportunity.
And of course, the time dimension is not the same, but we can already see that there was a lot of optimism in the system that, you know, people were concerned if energy prices would go up a bit or a lot. But if you, if they would have to go up so much that you don't use these sorts of energy, suddenly it became a narrative of a great opportunity. And I think we are paying the price for that in Europe now, that we were not, say, honest with ourselves because we wanted it to be a success, this transition, that we were too optimistic.
And we sold a story of, you know what, it's going to be good for the economy because we're going to invest a lot in green technologies and you're going to save the planet. That's option A. Option B is you miss on a great opportunity and you don't save the planet. What's your choice? That was an easy one. Now, you know, after two or three years of, say, contact with reality, we are coming back to this idea that there is a trade-off, there is a cost to going green.
And I'm not saying I'm against, actually, I'm very much in favour of going green, but we need to pay attention to the details. And one detail is that it has a cost and people will see that and you have to keep the public on board. So where I am on this front is basically, I mean, the science is the science and, you know, I'm certainly not disputing it. That's the easy part. And then the question is, how does the impact of climate change translate into economic effects, but also, and most importantly, if we want to go green, what are the economic implications? What is the cost? And, you know, what are also the best instruments to make sure that we have people on board?
ML
And what's fascinating is, is we've now got, we've got this pendulum, as you say, you know, there was this, you know, the 1.5 degree years, the decade, so Paris through till pretty much 2024, where the only thing you were allowed to aspire to was net zero 2050, globally for 1.5 degrees. The fact that other countries were not on board, it was sort of finessed. But then there was this big pushback, the contact with reality.
But what we've now got is, in a sense, fossil fuels, oil and gas are having their own contact with reality, which is when people say, oh, wind and solar don't pay their whole cost. They have these externality costs, you have to invest in the grid and etc, etc. It's much more expensive. So anybody who now says that it's going to be that yeah, but oil and gas don't pay their whole cost either, because the whole cost of volatility of commodity prices was not really priced in. The assumption was always oil was this gas was this, and then clean energy was doing this doing its own thing. Now we realise there's externalities on both sides.
So it's I think, maybe it's Hegelian, you know, thesis antithesis, and maybe we get the synthesis in the sense of a proper understanding of the costs of inaction, which are not climate costs, they're actually volatility costs.
PW
Well, I think it's both. I think it's I mean, I think the case for going green is still very strong. It is, of course, saving the planet. And you know, we know the cost of, of inaction will increase with time. Of course, in Belgium, we're not the most impacted we are at latitude where damage is going to be lower than say, in India and other countries. But but then, of course, you have ever more the geopolitical geostrategic case for more energy autonomy.
But let's face it, it's the first policy driven industrial revolution, most industrial revolutions are started because you have a technology that is better. And then you know, it's a one way street, you improve on the technology and people switch to that technology. You know, we didn't get out of the Stone Age because of lack of stone, it just we got a better technology to replace stones.
And that creates a double kind of uncertainty, you have uncertainty on the technology front. But in addition to that, and we had the green hydrogen bubble, and so on. So that uncertainty is in and by itself already an important factor. But then you have the policy uncertainty. And because you have wide swings in the way the problem is being perceived in the electorate, you are over optimistic, and then you go to doom and gloom. And the combination of those two uncertainties make it very difficult to to stabilise the price signal and regulatory signal in our countries.
ML
That's right. I think that what I would say is that just now that we see the cost of a commodity price spike again, then maybe it becomes less policy driven and more economic driven. And this is certainly the Climate Change Committee in the UK has just published its most recent analysis. And the headline of its kind of press release, the summary is one oil and gas price spike costs the country more than the net zero transition.
PW
Yes, but if I look at I think we need to distinguish between tradable and non tradable. That that's, I mean, one of the lesson of the last two or three years. So tradable is when you're in competition with the rest of the world, and I'm talking the energy intensive industry.
If you're not energy intensive, it's you know, it's it's another issue, but you can decide to go green alone and not without facing competition problems, heating homes, going for EVs and so on. And then it's a political choice that you have to make within your own electoral system. But if you're in competition with others, and the US is out of Paris, and some others have an objective of 2050 or beyond 2050, 2070 and others, it means that structurally, your energy intensive industry is not competitive, because you have to move to technologies that are more expensive.
And it's also one area where going green is expensive. We have relatively cheap technologies for households, for EVs, the prices are going down, we have heat pumps, electricity production, those are sectors where we can go green for a cost that it's very limited, if not at some point negative. But industry is expensive.
So we had the optimism about going for green hydrogen, the bubble has burst. We thought we could do carbon capture or blue hydrogen for 100 euro per tonne. That's gone, people talk about 200 euro per tonne, there is a lot of issues in terms of coordination, who is going to invest in the infrastructure, who is going to be the first mover.
Now, if you have higher energy prices, which is the case in Europe, since the war between the invasion of Ukraine by Russia, you have higher energy prices. And combined with that, you have to go green. You have an existential question about the future of industry. And this debate is now dominating, and it is impacting negatively the entire debate on going green. And it might be only 15% of emissions in Europe. But it's like, if there would be a clear choice between the economy and climate, where the tensions are essentially concentrated in that sector.
So we need to distinguish between the two, because otherwise, we risk throwing the baby with the bathwater. And maybe we have to open a window there and say, okay, it will take a bit more time. The idea was to go to net zero in Europe in 2040. For the industry, and that's within the scope of ETS1. This may be optimistic.
ML
Yeah. And I guess down the road somewhere else in Brussels, there's big discussions about relaxing those, that 2040 target and relaxing some of the requirements, very contentious discussions. But that's not, I mean, you are the National Bank of Belgium. So presumably, are you an observer or do you contribute to that conversation? Do you have a view as to whether 2040, industrial net zero should really be 2050, or even 2060? Or do you just stay out of that?
PW
Well, I'm an observer, and then I have a view. And then sometimes, you know, people would guess what my view is. So again, I mean, when I started, think, I mean, I worked in the energy sector, I was responsible for the pricing of gas and for electricity and gas was the incumbent here before going to politics and, you know, ministerial cabinets and the National Bank. So I know a little bit about the energy sector.
And my starting point was basically, you know, with global warming, we have an objective of 2050 net zero. This was decided in Europe. So I started from that. And I read this book from Bill Gates, How to Avoid a Climate Disaster. And it was talking about the green premia. So where in which industries you have to pay more to go green. And he said, you need to look at that, because this is the way to have a better understanding of what it implies to go green. And I thought this was a very good way to look at the issue.
And that's what we started doing at the National Bank was okay. One rule of a central bank is understanding the impact of major developments in our economies. And we do it at the European level, we do it at the Belgian level. So let's try to understand. And the best way to understand I thought was bottom up industry by industry or function by function, moving, warming homes, industry, and what are the technologies that we have? What is easy? What's the easy part? And what's the most difficult part? And we've been doing that for two or three years.
And it's allowed me progressively to enter the debate. So I was invited for a major seminar at the Peterson Institute. It was still Biden president, I did the opening speech. So I was a nobody on this topic. And they suddenly invited me to go there. We organised a seminar with Google at the National Bank to discuss the implication of greening and you came, which is where we met. So we sort of took a position in the debate, but from an analytical perspective, and I'm always very hesitant when you ask me about policy, because at the end of the day, it's a political choice. So, you know, it's not for me to decide whether we keep the 2050 objective in Europe or not, it will be a decision. But I think we need to be aware of how easy or difficult it is, what are the best instruments to inform the political discussion, and then it will be a political choice.
ML
As the National Bank, you've you yourself have been on a learning curve. And then you've got data and analysis that you've been building over a number of years, different reports, how much would it cost? How quickly can it go? What might be the inflationary impact? Can you summarise sort of what's the state of that right now? So how much would it cost for Belgium to go to net zero 2050? You know, within the concern, so you'll take the policy as a given, if you've done that analysis, how much would it cost? What are you actually talking about?
PW
In terms of this bottom of estimate, of course, there is uncertainty around it. But it's basically we look technology per technology, we look at the literature, we talk to people, and we arrive at 3.5% of GDP, full cost for the Belgian economy going green in 2050. And that's really it means that we would grow 10 basis point less per year, and that would be cumulative.
ML
Let me just make sure that I've understood and the audience can follow. That means that by 2050, the GDP would have been X. And if you go green, it'll be X minus 3.5%. That's correct.
PW
So that means that in terms of growth rates per year, you lose point 10 per year and that accumulates to 3.5%. That actually, in 2050, the GDP would have increased in the meantime. So it's 3.5% of today's GDP. So maybe it's 2.5 or 3%.
ML
Oh, I see. So okay. So, so we're at, let's call it, let's index it to 100.
PW
Yes, yes, yes.
ML
By 2050, you're talking about, I don't know, 130, 140, whatever, whatever it would be.
PW
Three and a half, 3.5 divided by 130. So 3.5 of 100, but 2.5 of the bigger number. So it means from a macro perspective, it means like it's a permanent oil shock. So we, we, we can do it. I mean, it's from a macro perspective, it's something our economies can absorb. I mean, you have a lot of debate in Europe, at least in some places about, you know, degrowth, negative growth or no growth. That's not the discussion. It's going green 2050 is going to reduce our growth potential in Belgium is maybe around 1% per year is going to, to, to take 10 basis points out of that.
ML
There's two things that I would sort of, you know, question, challenge. So one thing, did you look at, well, if there is an oil and gas shock along the way, that can also have a permanent impact of 2, 3% on the country's, you know, we, with COVID, we took a huge hit. We've not recovered fully to the growth trajectory of before. We've started to grow again at this 1% or whatever. But the other thing is, did you look at what happens after 2050? Because after 2050, you've done the bulk of the investment in the grids, in the generating capacity, etc. And do you not then have after that, perhaps even an enhanced growth rate, because you're no longer paying for fuel.
PW
It's not obvious, because of course, at some point, you will have to replace your investments. But beyond that, some of these technologies are also more expensive on a recurrent basis. If you switch from cheap gas at 20 euro per megawatt hour to produce heat in the industry, and you switch to electricity, for instance, if you cannot use heat pumps, because the heat is higher, you will be structurally more expensive.
That's just, so it's not only the investment. And if you use carbon capture, for instance, you lose inefficiency. So your energy use, you might still use natural gas, but the efficiency at which you use the gas will be lower. So, and, and, and, you know, in a way, what we did was not very sophisticated. We looked at the cost per technology, which is already a discounted cost. But my understanding is that you learn more doing that than just looking at the ballpark numbers that come from macro balls, because you will read in the literature, that model says, the cost is zero. Another one is 1% of GDP.
And then you just don't know where you cannot talk to people, interact with people in the industry, because you just have one macro number, where if you have a more granular view, then you talk to people, you challenge your numbers, and you have a discussion. And that's a little bit the problem is that the discussion came from models that were volume focused and technology focused, but in a way, what is the level of investment we need? So all these suites of model not focussing on the cost of the transition, but what is the level of investments, then macroeconomists took those investments, said, we're going to plug that in a macro model. And guess what, it's an investment boom. And it's then a plus for the economy.
And we missed the fact that this was a boom that would not increase productivity, but actually decrease it, but because you had to switch in some cases to more expensive technologies. And so that led to this great opportunity narrative, which, again, I think is a problem today, because we don't have a proper narrative in Europe, we told people, again, you're going to save the planet is going to be good for the economy. And now people realise, hey, no, it's not that easy.
So how do you land and it's really your, I mean, I guess part of your climate reset, which, you know, I'm 95% aligned with it. And I forgot the 5% that remain is, how do you land on a new narrative? How do you, you know, talk to the sensible centre is as you I think it's your own words, to make sure that you recreate a consensus in a debate that has become extremely polarised.
ML
Funnily enough, the sensible centre words that I thought I just picked up from somewhere or even came up with, it turns out that the person who first used that was none other than Tony Abbott. And so when I talk about the sensible centre, I mean, really sensible centre, as opposed to perhaps how it was originally meant by Tony, who was on the show a few years back, and actually somebody I know, and like quite a lot. He's a, he's a good guy, even though my audience is now going to go absolutely crazy, because he was not good on climate.
But I think it's a fascinating conversation. And I would love and maybe we're not gonna be able to do it today to get into the detail of that assumption. Because yes, some things become permanently more expensive. And actually, that maps onto your tradable commodity. So if you do primary chemicals, if you do steel, you're just going to have a more expensive and anything with high temperature, heat, ceramics, it's just going to be a cost. But that's actually quite a small part of the economy.
And what I find unsophisticated about the conversations in the commentariat is the confusion between cost and investment. Because if you've reduced GDP by three and a half percent, you know, to what extent is it because you've pulled forwards a whole load of capital expenditure, lots of grid investment, lots of wind farms, lots of solar, lots of energy efficiency, nuclear power stations, but you really honestly have set yourself up then for a lower energy cost, a lower fuel cost for decades and decades. So it's an investment, not a cost.
PW
I mean, it's true to some extent, but you know, what we really look at is the long run cost of the technology. So we discount it and we look at the levelized cost of the technology. And if it's more capital and less fuel, we look at the two. I hear too many people saying when you've done the investment, it's free. So let's do this. And it's like, I can buy your castle when I bought it, it's free. No, you still have to build the stuff. You still have to maintain it. So you hear that as well. We should, you know, if you accelerate the transition, that's in the Draghi report, then electricity prices will go down because the more you accelerate the transition, the more you will have zero or negative prices because you have too much wind and solar.
The problem is then the average cost goes below the levelized cost and you have cannibalisation and then you don't invest anymore in solar and wind. And actually, wind offshore is already more expensive, the level of electricity than we have now in Europe. So this is part of where people, I think, at some point want to be optimistic about it. And they are like, well, it's only about investment. It's not like we're going to have to pay for it beyond, you know, when you buy your house, you know, you buy one for a living in one life or maybe a second one if you're lucky.
ML
Now, I hear you. The one that I hate hearing is when people say, well, because the sun is free and the wind is free. And yes, but the thing that you need to do to capture it is not free. I mean, oil in the ground is also free. But I just, so I'm not going to argue that the optimistic scenario or the kind of the glossing and say, oh, well, it's all going to be just this enormous economic boom and an unequivocal contributor to jobs, and jobs are marvellous, because there's real costs. I think, though, that it's not, I'd love to know the assumptions that have led to two or 3% cost because it may be that afterwards the...
PW
It’s a bit like the 80-20 rule. So one thing we need to understand very well on climate and you, of course, you know that is that the costs of the different technologies are very, very different, but like very, very different. So some technologies would be cheaper. They will just be cheaper and competitive. And some of the renewables are already cheaper and competitive. You've got battery costs going down and so on. So my guess is we can probably, with the improvement in the technologies on the EV front, battery front, and so on, we can probably green our economy, half of our economy, for a cost that's close to zero.
And that's the no brainer one. So you really have to cross the costs of the technologies with tradable, non-tradable. Everything that is competitive in itself will be done. And that's going to be already a lot. I think we can probably green the economy 50%. It's again, it's about EVs, batteries, it's about heat pumps. And then you have maybe 25 for which it costs something, but it's around the price we're already paying for fossil fuel. Like we have ETS, we have taxes on gas, we have oil mostly, gas less. This is the part which we should be able to do. But when it's tradable, it's already becoming sort of an issue. Then if the cost is over 100 euro per tonne, you cannot use heat pumps for industry, because you go beyond the 400 degrees or whatever. You need some fossil fuel in the chemical industry, you need to go for carbon capture. That's very expensive. And that's really the 15-20% that is very, very difficult to do. Now, if we do all the rest in Europe, we'll be at 1% of worldwide emissions. And that's where I'm like, the last mile, it will be part of political discussion. I don't even care so much because if we are at 1% of the emission, the problem is with the rest of the world.
ML
I spent a number of years at McKinsey. So when I'm listening to you, I'm seeing a three by two matrix, which is really about you've got tradable and non tradable. So where there's tradable in the climate world, that would be the areas where there's going to be carbon leakage, where if we are not competitive, they'll simply make commodities somewhere else, without worrying about climate.
PW
Lose, lose, lose.
ML
You've got tradable, non tradable, and then you've got stuff that totally makes sense, that's affordable. And then you've got the last and I think it's probably sort of 5%, 3, 5%, maybe 10%. And it would be just, I think it's really, we're on a journey to understanding what's in those boxes.
So I think I'd love to dive into that. But I agree with you. I mean, that's very consistent with my pragmatic climate reset, that we don't worry about the last few percent. And we're very targeted in I think in the support or in our very nuanced in the policy for the tradable for the where there's leakage.
You use an interesting word that I don't care. And I can imagine, you know, because you have some critics out there who latch onto that, that he doesn't care. Because when you were reappointed, you were appointed in 2019. When you were reappointed, you had a bunch of NGOs here in Belgium, there was a Positive Money Europe that wrote a letter. And the wording they used, I found very interesting. They said you were ‘not equipped to meet the challenges of climate change.’ Not that you didn't want to, or that you didn't, that you didn't, I don't know, maybe it was to do with not caring, but they said that you were not equipped. And talk to me about that kind of scrutiny that you get from some quite sort of ideological and quite frankly, not pragmatic climate reset, accepting people.
PW
It's interesting, because it had nothing to do with the 2050 objective, I was fully supporting it. And I was actually I’d just been invited to the conference at the Peterson Institute. I think I mentioned it. So I was known as someone who cared about climate and was looking at the issue. But then we had a discussion about whether the central bank should do something about it. And I was like, of course, we should study it and look at what the impact will be on the economy.
We should look at the risk as we look at any risk. But that's more like from a supervisory financial stability perspective. But we should not be doing policy.
And honestly, this is very consensual in the US. Even I mean, I'm talking in the time of Biden. And when I talk to people at the Fed, they're like, you know, that's not our job. It's for politicians to decide. But at the ECB was less clear. There was this idea that we should support because in the treaty, the green policies and…
ML
Pierre, we need to acronym alert, because some of our audience
PW
Sorry, no, sorry, the ECB is the European Central Bank.
ML
Sorry. Keep going.
PW
So European Central Bank. And we had it. It's interesting from a sociological perspective, because central bankers tend to have, we meet a lot, and we have the same view of the world. It's a very homogeneous group. And on many, many issues, we agree on that one, there was a clear difference between the US and Europe, where in Europe, I was the bad guy, because I was saying, it's not the role of the central bank to do policy stuff, where in the US, they were clearly ‘Yes, of course, we agree with Pierre, but in a way, they disagreed.’ But I think at the end of the day, it's a question of personalities.
ML
But even within Europe, there was always because I remember a conversation or a debate between there was Christine Lagarde was saying that the central banks should tilt the playing field for climate. Yeah. And Wolfgang Munchauer was saying, no, they shouldn't. And so I mean, when I'm going back, I'm dating myself.
PW
We had two dissenting voices, basically Jens Vedman and myself, the German and myself. And you know, we need to look at the risks, we can come back to how we looked at the risk, because I think we're not always very. Okay, let's come back to that afterwards. But my point was, if you start doing that, that's tilting your instruments and so on for climate, then you do policy stuff. And by the way, what we did was extremely symbolic. So it's a conceptual discussion. But now the big issue is the war. I mean, should we tilt our portfolio to support the defence industry? Nobody's asking for that.
And then, you know, if you don't do it in one direction, but you do it in the other, then you're put in a camp. And when an issue becomes polarised, climate is becoming polarised, then the ECB or central bank is perceived as being in one camp. And that's something I think we should not play that game, we should have a clear view of our mandate. Independence is something that you need to deserve on a day by day basis. It's a privilege that you have, we are independent, we should then stick to a very strict mandate and not do policy stuff. And what we did was extremely symbolic, it's not like we had a big impact. But I would claim that we were already entering to some extent into the policy field.
ML
On the other side, we had an episode with Ma Jun, who was formerly with the People's Bank of China, on the Monetary Policy Committee, and he's the father of green finance in China. And what he laid out was this kind of full orchestra of all the ministries are on board. And then the central bank is supporting by very much tilting the playing field towards green finance.
PW
Of course, China is a different system. And I don't think the central bank is as independent as we are. You know, if if a central bank would not be independent, and it would be tasked as the Bank of England was because the minister, as I say, was tasked to do something, then I'm completely fine. If we would be tasked with, but we're independent, so we're not supposed to be tasked with something in Europe.
ML
So if you want, if you want the central banks to do this stuff, give them a clear mandate, give them a...
PW
Precisely. And I don't think we've got good instruments, but that's yet another discussion.
ML
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ML
You are responsible for stability. And so there's been a lot of activity. There's the Network for the Greening of the Financial System, NGFS. We can now use the acronym because I've defined what it is. But that's a group of many, many of the central banks. I think the US has now left the NGFS, but was in it for a long time.
And the NGFS has been saying there are stability issues and there are scenarios we must run. And we must be very scared of financial instability because of climate, for whatever reason. Mark Carney, of course, now…
PW
He changed his position on climate, no?
ML
I don't think he's changed his position. I think he's become Prime Minister of Canada. He was on, he came on Cleaning Up.
PW
Well it’s interesting anyway?
ML
Well, how can I put it? I think that he's, you know, obviously, governor of the Bank of England. And then shortly after he left that, and he was very involved in all of the climate finance stuff at COP26, so in Glasgow, and then came on the show. And he was almost a kind of single issue advocate for a while around climate finance, and then gave his famous speech where he defined the three risks: the physical risk, the liability risk, and the policy risk. And he was the standard bearer for the kind of almost, I don't want to say the collapse theory, but the stability theory. And now he's got different pressures and good luck to him.
PW
That's where I think, especially when you're an independent central bank, you should not start from a position. I'm comfortable, I'm independent, so I will defend something different. You have to accept that you live in a political system. And, you know, politicians will decide, and it's for them to decide. And if you disagree with them, it's not your role to try to compensate.
ML
Right, but you did the analysis. Is there a collapse risk?
PW
On the risk front that we would do it conceptually is a no brainer. Of course, we need to look at it. So we came with some analysis which were showing a significant risk. But then you have to redefine Prince because it was really a scenario where the narrative was a bit like, we're not doing enough. Suddenly, politicians will realise we're not doing enough. And they will basically impose an all price of 300 to 450 dollars per barrel. And therefore, there is a big risk.
ML
So in the Mark Carney framework, that would be then the policy risk, not the physical risk, not the transition risk, but the policy risk.
PW
The transition risk that they would suddenly impose a huge cost on the economy because they would force a very, you know, expensive and fast transition.
ML
And so this is the NGFS's disorderly or the European Central Bank was running this disorderly.
PW
So you have the orderly scenario with a carbon price of 600 euros per tonne, which is already huge. I mean, we are at 100 in Europe. And this is already was 1000 euros. So that corresponds to more or less an all price of 300 and then 450 dollars per barrel. So it's really basically saying, beware, because suddenly politicians will decide to do that. And then they will look and your economy is going to go down the drain. And I'm like, this is not going to happen.
ML
But already 600, the orderly transition, which is a 600 euro carbon price, you said, I mean, in my pragmatic climate reset thinking, anything over 200 euros is already politically probably impossible for the leakage or just for people's cost of living. And during the transition, this idea that you can push people's costs up and then eventually innovation happens and it'll come back down again, I just think it is for the birds.
PW
I think behind that, you have people that really believe that at some point there will be an acceleration, a transition like, you know, the tipping points or whatever. I mean, my understanding of tipping points is that they unfold in decades, if not 100 years. But there is this idea that suddenly we could lose control and then, you know, gloves are off and suddenly you would have to take those tremendously expensive and forceful measures. I'm like, the likelihood of that is extremely small.
ML
But it's also not the disorderly scenario, because that's then a scenario where, you know, that where there is.
PW
An orderly scenario, 600 is indeed not our orderly scenario. It's already very, you know, tough.
ML
Right. But I suppose it could be the disorderly scenario, because it could be what you're saying is there is a scenario potentially where there is some dramatic climate event. The meridional there was at the AMOC, the Atlantic Meridional Overturning Current stops and there's permanent winter in Europe. And at that point, there is an intervention which is much more dramatic. But I think, I am with you that, how can I put it, expecting or hoping for this dramatic climate impact in order to drive a policy response just seems pretty far to me. Let's face it.
PW
I think, again, I was mentioning narrative, but I think the biggest problem today, we have a polarised world and the climate discussion is basically Trump on one side saying it's a hoax, the climate change and other seeding that you have to dismiss Trump. And they will. You know, we have aligned ourselves to the for instance, you have a lot of uncertainty in the modelling of the impact of the climate change itself to the economy.
It's a literature I know a little bit less, but I've been digging more recently. And you have a lot of uncertainty about what the impacts will be. But what I can see is that our institutions and NGFS, the planning bureau in Belgium, we've aligned ourselves to the highest bidder on the climate impact front very quickly.
So the more Trump says one thing, the more we'll be digging and looking at the one paper that is the most dramatic. And this becomes the reference for us, for our world very, very quickly. So you had this paper that is being unpublished by Nature, that had become the reference of all these institutions, the planning bureau in Belgium, the NGFS. And this means that we are also moving away in a way from the sensible centre. We are sort of having a fight with Trump. He says a hoax. And we say, no, no, we have this paper saying this is going to be dramatic.
Now, we know that the costs of inaction are going to increase. I think there is uncertainty, especially for a country like Belgium, how big that is going to be. But if we cannot have a narrative where we can regroup and convince 80% of the population and keep fighting over the Atlantic with Trump, then the quality of the regulatory signal is gone. And it means that I'm afraid of death by a thousand cuts that, you know, nobody's ever going to have the discussion on what really the ambition is. But each time you will come with one policy instrument, they will say, we need to do it. But not that one. We need to do it, but not that one. And that's what we see now in Europe is that the instruments are being questioned.
ML
And that's very much how I see it is that we absolutely have to deal with emissions. Climate change is real. It is driven by emissions. We have to deal with emissions. But if we try to go too fast, we actually don't move at all.
PW
No because you get a backlash.
ML
There's a backlash, which is what we see.
PW
So you need to take that into account in the picture. And that's why, again, going back instead of running these macro models with one number, going back to the cost of the different technologies, I'm like, again, there is a 50 percent that is a no brainer. Let's do it. And there is a timing dimension. You know that EVs are still expensive today, but the costs are going down. So, you know, let's focus on that. And for the most expensive technologies, let's see what we can do. And it will require some public support.
ML
The critique that I think we need to deal with then is, yes, but that extreme scenario is not impossible. So you can't say it's not going to happen and just assume that we'll be OK if we go towards, you know, whether you can call it a two degree scenario or however you want to define it, two and a half degrees, 2.2, whatever. And so what I would like to see more of in the discussion is what they call in the climate world adaptive pathways.
In the finance world, it would be called real options because there is a chance of a much worse outcome. But then the question is, what information do we need and when could we get it and how do we invest in flexibility so that we can assume that the median outcome is the one we're headed to? But then every five years or 10 years kind of check that we're not in an outlier outcome. And I think that politicians find that they kind of say, well, that's great in theory, but how the hell do you communicate that to people? You know, they want to find a scenario, build their plans, communicate it, bang the drum. But that drives to polarisation.
And I would like to see much more nuance and option value being built into the system.
PW
I think we need to recentre the discussion on what can be done relatively easily and is going to have an impact over the coming years. And, you know, again, it's greening electricity projection, it's heat pumps, it's EVs. And again, EVs are still more expensive. So sometimes waiting a little bit for the people that buy small cars and don't have the money might be an option. And you can do already a lot. And then you go for industrial heat pumps where you go for 200 to 300 degrees and so on.
And at some point, you have to move to areas where you need public support, public support for R&D, public support for analysis of the risk, public support for investing in the first generation of some technologies, for supporting, you know, the infrastructure for carbon capture. If you let it be done by a carbon price, I'm afraid you need a carbon price that is too high. So the carbon price, of course, is the most efficient instrument. But the problem is because the marginal technology being probably direct air capture is so expensive, you cannot do it all with a carbon price. So the carbon price for me is the wave that is going to move all the boats at the end of the day. You start with that. And then on top of that, to go for the most expensive technologies, you build up from there with subsidies, with R&D expenditures, with risk analysis. And then you go to the net zero.
ML
I like the approach that you kind of, you know, that you're nuanced. So it's sector by sector, traded, not traded, and then a bundle of instruments. I have to be honest, I am not a big fan of carbon price. You know, this kind of thinking that says, well, of course, the most elegant is the carbon price, because what I've seen is investment committees and also bankers, debt providers, they discount carbon price when they're making a capex decision. So carbon price is fabulous for the dispatch decision. Should I run this plant or that plant? I just calculate fuel cost, carbon price, commodity prices, price of the electricity or whatever it is, and it works.
But when you say we're going to, we need to know what the 15 or 20 year forward carbon price is in order to justify this investment, then the carbon price gets discounted and bankers don't lend against the forward curve of carbon prices. They discount it enormously. So I'm not even sure that in theory, I mean, I know the economic theory sort of says carbon price is most elegant. I think it's wrong.
PW
I think we can agree if we say a credible carbon price, and you're telling me it's not going to be credible.
ML
And that's but it's not regarded as credible.
PW
No, no, no, I think you're right. And I think that's a discussion we need in a way to reopen if, you know, politically today in Europe, if you say I want to rediscuss 2050, you will have a lot of people attacking you. So people don't do that. They attack the instruments. They say, you know, I'm fine with the 2050, but not with that and also not with that and also not with that. And then the problem is, of course, that the instruments are not credible. And we need to find a way for investment for the instruments to remain credible, because in many cases, indeed, especially in industry, you take decisions for the next 20 years. And if you don't have a credible regulatory setting, being it a price or something else, they won't invest.
ML
Can I ask… on your governing council, you meet every six weeks. Do you talk about carbon price? Is that a topic ever? Because, you know, right now there is a conversation. If you look at the models and you look at the forward, you know, what happens to the carbon price based on the EU ETS, the European trading system for carbon, then it's going to go to 200 or 250 euros per tonne. And there's a big pushback, Germany and others saying we're going to have to weaken this. And do you and your colleagues… is there an official position or conversation or not?
PW
We're not having that kind of discussion. We are having the discussion if ETS 2. So the one not for the industry, but for households…
ML
Heating, transport, yup.
PW
… will be introduced in the coming years. What is going to be the impact on inflation? That's the discussion we are having. The more sophisticated discussion about what you just said. And it's interesting because, you know, one of the father of the ETS published a paper recently. It's Jos Delbeke, I guess.
ML
Jos Delbeke, yes, good friend.
PW
He said basically, he was also at the conference and he said basically, yes, indeed, if we want to move to net zero 2040 in the industry, the carbon price will have to go to 300 euros per tonne. And this is not going to be politically feasible. He says this is going to be difficult. And then he says, maybe we need to have some kind of way to cap that increase. So this is, again, I think this reasoning, my instrument can be conceptually the best one if it's politically not credible, then it's worth nothing. So we need to take into account the political dimension to land on something that will convince the investor that it's indeed a relevant price signal.
ML
But shouldn't the EU grasp the nettle and say what we really need is a credible carbon price. So what we need is a carbon central banker, somebody like yourself, who says, I am going to, you know, I'm tasked with the mandate is 100 euros, 120 euros by 2030, 160 euros by 2035, whatever the number is. And then with a bunch of instruments, because what's actually happening is that the politicians, they intervene in a sense to set a carbon price, but they do it in this very obscure, very non-transparent way by, you know, in some cases they'll do this reform and sell more credits or remove some. But it's all done by committee and there aren't any standing instruments that a central banker would say, well, I'll take the job, but only if I get this and that and the other tools.
PW
Well, I don't like the idea of a central bank because it's going to create confusion, but you call it something else. But you could have the commission or someone trying to buy and sell in the market to kind of stabilise the price. There is an issue, though, that we could not put a tax on carbon because you need unanimity. So we went for a trading system where the volume is the reference. And so the volatility is in the price. You can try to constrain the price movements, but of course, at some point someone is going to ask, but where is your instrument to go to net zero? Because with the volume, it was easy. You could say, well, the volume is going to go to zero. But if you say, I want to stabilise the price, you accept the idea that the volume becomes the adjustment variable to some extent. And it doesn't go to zero in 2040 or 50.
Today, it's in a way illegal to say that in Europe because we have committed to 1.5 and to 2050. And another of my concerns is that you have ever more tension between what politicians are deciding on the margin, you know, attacking some of the instruments where legally you still have the objective there. And then you have, you will have NGOs attacking some investment decisions saying they are not net zero compatible. And it's going to be a mess.
ML
I would argue that it already is a mess because there are already the conversations.
PW
A worse mess.
ML
It could be a worse mess. It could be. But I mean, the funny thing is I've been doing this for now over 20 years. And these are the same discussions. Do you do price targeting? Do you do volume targeting, et cetera, et cetera? And of course, now we've got this whole architecture of ETS, ETS2 when it goes over to heating and transport and so on, and then a whole load of other instruments that are now built on top of it. So the way they use some extra credits to pump prime aviation fuel or the way they use credits to do all sorts of things. So it is a mess, but it would be, I think, a bigger mess to try to change it. And that's part of Europe's problem, though, is the inertia of, you know, 25 years of building architectures of this stuff.
PW
But, you know, then the problem is if you are in the industry in Europe and cement is local, so you could say cement is, you know, again, my matrix 3.2, 3 to 2. But if you are in an industry heavy sector and you are in competition with others, you cannot invest in brown. That's gone. Green makes you uncompetitive unless you've got subsidies. And in fact, you have a sort of trilemma at European level today because others are not going green. You have a trilemma between openness, the single market and climate. You cannot have the three. So, of course, you could say we're going to retreat on openness and then you have a green European economy. We don't compete with others. It's fine. OK, but then you have, you know, to give way on openness.
ML
When you say openness, you're meaning trade being open. That's the C-CBAM that says we're open for trade. So we're going to be fortress green.
PW
And then you put CBAM and much more. Then you can protect Europe, but you have to basically become a more protectionist economy. You could, of course, say we go for climate and we remain open for trade, but then your industry is not competitive and then you need subsidies. And that's what you see today. But Europe does not have the money. So the subsidies come from national governments or regional ones. So we are actually damaging the single market. Now in the industry, if you want to invest, you rely on subsidies. It's not a single market anymore. It's really you rely on national or regional subsidies. So we have this tension. Of course, we could also say we are less ambitious on the climate front. That's the easy one, not the one I'm pleading for. But so we have this tension between being open, preserving the single market and the climate ambition. And those trade-offs are not really being discussed.
Again, my concern is that because the debate is polarised, nobody wants to rediscuss the objective. So we focus on some of the instruments. And let's face it, today, it's moving in the wrong direction that we see instruments being… There were some of the instruments, I think, which were wrong instruments or not efficient instrument that for me we can drop, like, you know, I think on the reporting front, the idea that we would green the economy by imposing reports to everybody. I think that's not working. So I'm fine with dropping those instruments. But if we drop most of the instruments, we are left with a target without instruments. And that's not OK.
ML
It's almost like we need to explore this strategic playing field. And one could envisage a role-playing game.
PW
Yeah, I'm a role-playing gamer.
ML
You're a role-playing game person. And so you could have a role-playing game played perhaps amongst your ECB colleagues behind closed doors in one of your six weekly meetings, but perhaps at the Belgian level, but probably not. It needs to be at the EU level.
But so kind of, I don't know what it would resemble, Dungeons and Dragons, what would be your suggestion?
PW
I started with Dungeons and Dragons. We mostly play Call of Cthulhu, but it's the same principle. We go in the basement. We have a table, no costumes. We roll dices and we save the world.
ML
I hope you always do save the world because Call of Cthulhu is actually based on this idea that it was H.P. Lovecraft. He said that the oldest and strongest emotion of mankind is fear. And so the game is designed to be as scary as possible, as I understand it.
PW
But that's, you know, I'm coming back again to the narrative. You have two narratives. One is the greater opportunity narrative. That one is not working anymore. The other one is project fear, you know, coming from Brexit. But that's the other one. We frighten people. That doesn't seem to work either.
ML
So what we need to do is explore the space between inaction and project fear.
PW
It's your climate reset. I mean, we are like, you know, we meet in a, I mean, the sensible people. We meet in a room and we're like, do we have a political mandate to go for net zero and something that is going to create a cost for some people in the economy? Let's look at the instruments. Let's look at the best way we could do it. And then if we agree that we have a very good way to do it and it's politically feasible, we do it. If then the political censor says, yeah, that one, the best way to do it might be a bit difficult. Where? And then you start the discussion.
ML
And the strategic game board, I imagine, for this is a three by two matrix.
PW
And if anything, you know, the problem, I think, is indeed the energy intensive industry. And especially because, honestly, the objective was not 2050, but 2040.
ML
I think that in terms of the uncertainties, the difficult stuff, I agree, is the energy intensive industries. But the politics is being driven by boilers and cars and, you know, the energy choices of small businesses, which, in my view, is actually pretty straightforward. We kind of know what we need to do. So it's a mess. I'm completely with you again.
PW
I think that the gilets jaunes in France did a lot of damage. So politicians realised, oh, we are going to face opposition by households. But industry, industry is just going to pay.
So we put on the ETS1, that's industry and so on. But they were reluctant to go for households because they thought they are going to revolt and they vote for us. Now, the problem is, in the meantime, what we realise is that greening the economy for households is quite easy. It's it's about heat pumps, EVs and so on. Again, timing dimension, but we can do it.
But the difficult part is the industry. And now there is an awakening to that reality. And it's ugly because suddenly people are like, hey, we don't, we don't want this. We want something else. We don't have something else. And again, it's the energy intensive industry in the tradable sector. Cement is mostly local. I would say it's not easy. It's costly, but it's not an issue of competition. So let's stick to what's really is difficult. You don't want to close. I mean, politically, if you close some big production units here in Europe and you lose thousands of jobs to reopen them in the US… it's lose, lose, lose.
ML
Yeah, we are running out of time. We're out of time. Let me try and summarise, see how I do. On a technocratic basis. It's straight, relatively straightforward. It's possible to see how you navigate the three by two matrix, what you do in these different sectors, the politics and the regulatory book that's been built over 20, 30 years in Europe is kind of a mess. And it's not the role of the central bank to step in and fix everything, but to steer a steady course, make sure that we still got sound money, risk management, good information and so on. Is that a fair summary?
PW
I think we can help define the nature of the problem, recognise it's a political discussion at the end of the day and hope and welcome an informed discussion that is really informed to save. You know, the objective of greening our economy, because I'm really concerned today, again, the story of death by a thousand cuts, where politically people would say, yes, of course, we want to do it. But actually, they disagree with the instruments.
ML
The Thomas Aquinas approach. Lord, make us virtuous, but not now.
PW
That kind of stuff. And that's where completely I'm aligned with you. We need a climate reset. We need to reopen these discussions so that we have a credible narrative with a credible set of instruments.
ML
Thank you very much for taking the time to talk to me today.
PW
Thank you. It was great. Loved it.
ML
Thank you. So that was Pierre Wunsch. He's the governor of the National Bank of Belgium. He's on the governing council of the European Central Bank and the board of governors of the International Monetary Fund. As always, we'll put links in the show notes to resources we mentioned during the conversation. So that is the research undertaken by the National Bank of Belgium into climate related issues over the past few years, as well as the episode with Ma Jun, former member of the Monetary Committee of the People's Bank of China.
And with that, I'd like to thank the team at the National Bank of Belgium at whose headquarters we've been filming, as well as our producer, Oscar Boyd, video editor, Jamie Oliver, head of operations, Kendall Smith, the rest of the team behind Cleaning Up, our leadership circle, without whom none of this would be possible. And of course, you, the audience, for spending some time listening and watching this episode.
Please join us at this time next week for another episode of Cleaning Up.
ML
Cleaning up is proud to be supported by its Leadership Circle. The members are Actis, Alcazar Energy, Arup, Copenhagen Infrastructure Partners, Cygnum Capital, Davidson Kempner, EcoPragma Capital, EDP, Eurelectric, the Gilardini Foundation, KKR, Mitsubishi Heavy Industries, National Grid, Octopus Energy, Quadrature Climate Foundation, Schneider Electric, SDCL and Wärtsilä. For more information on the Leadership Circle, please visit cleaningup.live. If you're enjoying this episode, please hit like, leave a comment and also recommend it to friends, family, colleagues and absolutely everyone. To browse our archive of around 250 past episodes and to subscribe to our free newsletter, visit cleaningup.live.