In 2014, the economist Natacha Valla, Deputy Director General for Monetary Policy at the ECB, proposed the establishment of a Eurosystem of Investment Banks (ESIB) ‘around a pan-European financial capacity that would coordinate the actions of the [state] investment banks of Euro area member states and add to their funding capacity’.¹⁸ Building on the existence of a network of prominent SIBs across Europe and the EIB, the ESIB would institutionalize their occasional successful cooperation — notably the so-called ‘investment platforms’ — in European Law with the binding mandate of promoting sustainable and inclusive growth, and employment on the continent. Considering the risk of climate change and environmental collapse, this mandate should involve the transition to a sustainable and low-carbon economy.

The proposal is to finance investment at an economically relevant scale of €1 trillion per year, but it was also suggested that the European Fund could issue debt to finance itself on the market. While the actual abundance of liquidity could advocate in favour of such an option, it is neither the only way to go nor the best as it incentivizes SIBs to select profitable and not- too-risky investment in order to keep their generally good rating — the kind of investment that could easily attract private money.

Of the many ways SIBs can finance their operations — including taking savings and deposits from the public, borrowing from other financial in- stitutions, receiving budget allocations from the national Treasury¹⁹ — we think there is room for reinforcing one particular channel of funding: the central banks.

Money creation for the people?

We tend to forget that how we create money and the quantity in circula- tion are key in our economy; the latter can potentially restrict the value of transactions if too low and lead to inflation if too high. The role attributed to central banks is precisely to ensure a proper level of money in circulation to realize the economy’s full capacity and reach full employment.

But who is creating and allocating money is also an important issue to address. With commercial bank lending now the main source of money issuance, it is important to know under what conditions and to whom banks are lending. Compared to private banks that are designed to provide funding for profitable activities and not-too-risky clients, public banks can be democratically mandated to pursue other objectives such as social inclusion, full employment and a transition to a sustainable and low-carbon economy.

The limited and not-so-effective central banks toolbox

In response to the 2008 crisis, major central banks promptly reduced interest rates to near-zero in an attempt to make it cheaper for private banks to lend money to businesses and individuals; in a less conventional move they also launched ‘quantitative easing’ (QE) programs that allowed them to create money and purchase various financial assets, including government and corporate bonds. The money injected through QE was supposed to trickle down to the real economy by pushing financial markets and banks to lend more. In the Eurozone, QE was also meant to make it easier for governments to sustain their deficits, by reducing the interest rate and the risk on government bonds.

Launched in 2015, QE as implemented by the ECB has resulted in the creation of more than €2.6 trillion. Following the principle of so- called ‘market neutrality’, the ECB bought bonds on the market without differentiating between ‘brown’ and ‘green’, or between socially useful and harmful investments. While this policy massively directed towards Euro- area sovereign bonds has successfully stopped speculation on the poorest countries in the region, the ECB has so far failed to achieve its primary mandate of maintaining inflation close to 2 per cent despite this massive injection of liquidity: inflation is still far below that level.

This comes as no surprise. Firstly, cheaper borrowing does not necessarily lead to increased demand from households and companies, especially when they already have a hard time repaying their existing debts and when the economy is depressed. Secondly, given monetary policies are intermediated by a dysfunctional financial sector, money does not automatically reach the real economy: financial development since 1990 has mostly grown thanks to credit for real estate and other asset markets,²⁰ not business lending. For example, by the end of 2017 ‘almost 40 percent of ECB-created liquidity was kept idle on credit institutions’ deposit accounts at the ECB itself’²¹ rather than used to provide new loans to the real economy. In this context one wonders how QE could stimulate the economy.

Many economists are currently debating whether central banks have exhausted all their options, implying that they could not cope with another financial crisis. This sheds light on the limitations of the current monetary policy toolbox and reopens the debate on other instruments, especially coordination between fiscal and monetary policies.

The use of a central banks’ money-creating powers to help finance public investment is not a new idea. A number of economists advocated for similar policies as a response to the Great Depression in the 1930s.²² Before the era of modern banking, several governments ‘used simple accounting techniques … or printed paper money to fund their activities and ensured their widespread adoption through taxation’.²³ There are also many examples of fiscal–monetary coordination through history, in particular during the 1930s to 1970s period.²⁴

Despite decades of fruitful coordination between central banks and minis- tries of finance, such practices have become taboo with the establishment of a New Macroeconomic Consensus (NMC) in the 1990s. Inflation targeting has since become the primary focus of monetary policy, taking over other macroeconomic policy objectives such as full employment or sustainable growth. The NMC’s two other key elements are: first, that central banks should be strictly independent from government; second, that they solely use indirect methods of monetary policy (e.g. interest rate adjustment) versus direct methods (e.g. monetary financing of public investment or some forms of credit guidance). In 1992, the Maastricht Treaty institutionalized this consensus in Europe by preventing any government from monetarily financing public investments.

However, this consensus was called into question after the 2008 crisis, reopening the discussion on using central bank money creation to support public investments. Following the resurrection of this idea in 2003 by the former chairman of the Federal Reserve, Ben Bernanke, it has been endorsed by notable economists, including the former Financial Services Authority chairman Adair Turner, the Citigroup’s chief economist William Buiter, the Nobel Prize-winning Paul Krugman and others.²⁵

A partial monetary financing of public investment through such coordi- nation could help close some worrying investment gaps — such as for the transition to a sustainable and low-carbon economy — and influence pro- duction and employment, directing capital where it is most needed, without heightening the public sector’s debt. Nevertheless, for most policy-makers, ‘printing money’ to finance public spending remains a mortal sin²⁶, as it triggers fear of hyperinflation.

Monetary financing to prevent climate breakdown

Creating money is what the banking sector does every day. The question is whether this new money created corresponds to real productive activities that fulfil society’s needs, or if it is going to inflate the price of existing assets, creating a risk of a bubble and artificially expanding the wealth of the few. Redirecting money creation towards real activity, especially for the transition, would certainly not bring any uncontrollable inflation.

To make it politically viable in Europe, the main characteristics of our pro- posal would be:

• Conditionality – To overcome the mostly irrational fear of triggering hyperinflation, monetary financing would be made conditional, so that bond purchases would be automatically stopped in case of a too-high surge in inflation – as has been proposed by some economists.²⁷
• Reallocation – The funds would be made available to every SIB accord- ing to country capital key,²⁸ for the purpose of financing long-term public and sustainable investment projects.
• Guarantee – The creation of a Eurosystem of SIBs combined with a pre- announced and substantial volume of purchases by the ECB of newly created ESIB bonds will act as a strong guarantee for this new mechanism. This will allow SIBs to fund riskier and less profitable — but necessary — projects with public good characteristics, and to benefit from extremely low interest rates in case the ECB stops buying ESIB bonds beyond a certain threshold.

Furthermore, it is worth noting that this could eventually be done without new money creation. Despite the supposed end of quantitative easing in December 2018, every time a bond will arrive at maturity, the ECB will reinvest the correspondent amount of money into new bonds²⁹ — the same sort of reinvestment will happen for years to come. The ECB could therefore decide to buy a greater amount of ESIB bonds with this reinvestment. As the ESIB would mainly emit green bonds directed towards the transition (e.g. sustainable infrastructure), reinvesting QE that way would allow the ECB to finally channel it towards the real economy and fulfil its duty as an institution legally bound by the Paris Agreement on climate change.

In any case, this would help to quickly close the investment gap in the areas of climate mitigation and sustainable infrastructure, while reducing general levels of unemployment.