Fossil fuels and the new threat to economies

By Rabah Arezki

Published: Wed 19 Feb 2020, 8:00 PM

Last updated: Wed 19 Feb 2020, 10:39 PM

The climate threats to financial stability that central bankers worry about could arise not only from increasingly frequent and severe natural disasters, but also from the shift away from fossil fuels as a source of energy. That transition ultimately would turn reserves of oil, natural gas, and coal into stranded assets, jeopardizing the financial health of corporations, insurers, and other financial institutions that are exposed to fossil fuels.
The overall exposure of advanced economies such as the United Kingdom or those of the European Union to fossil fuels may appear to be relatively small. Nonetheless, we should not underestimate the systemic risk posed by stranded assets - after all, the 2008 global financial crisis was triggered by developments in the relatively small subprime mortgage market in the United States. And, for fossil-fuel exporters, stranded-asset risks are undeniably larger.
The collapse in oil prices that started in June 2014 provided a recent stark reminder of the risks posed by excessive dependence on fossil fuels.
Until now, the extensive research into which macroeconomic policies are appropriate for fossil-fuel exporters has focused much more on the role of fiscal policy. Part of the reason may be that most fossil-fuel exporting economies have currency pegs or relatively fixed exchange-rate regimes - meaning that, in the absence of capital controls, they have no independent monetary policy.
Today, however, there are good reasons to take a fresh and broader look at monetary policy in these countries. Traditionally, the monetary-policy horizon has been limited to that of the business cycle - typically 2-6 years. But given the high degree of wealth concentration in fossil fuels, the strong complementarity between fiscal and monetary policies, and the emergence of new risks to fossil-fuel assets, central banks must look beyond the business-cycle horizon.
- Rabah Arezki is Chief Economist of the World Bank's Middle East and North Africa Region

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