Central banks typically associate climate-supporting measures with an expansionary monetary policy stance. Accordingly, such measures are thought to be inappropriate in an inflationary context. Against this view, we highlight a longstanding tradition in central banking which held the contrary: it is desirable to protect some sectors during a tightening cycle because certain types of investment prevent, rather than cause, inflation. This view is informed by examples of policy that was made at the German Bundesbank and other central banks, and made in ways that were entirely compatible with economic liberalism and central bank independence.

There are several reasons for central banks to use green credit policy in an inflationary context. First, a lack of sufficient green investment is undesirable in terms of ensuring long-term price stability. Second, the high upfront costs associated with renewable energy production and infrastructure makes them particularly sensitive to interest rates. Third, monetary policy that seeks to bring down inflation in the short term by restricting investments in climate mitigation would make the global economy more vulnerable to future climate- and biodiversity-related economic shocks, including adverse shocks to price stability. Fourth, a lack of green investment would also expose the domestic economy to stronger price shocks to high-carbon energy or other goods whose production is affected by ecological transformation. Fifth, the failure of central banks to consider the environmental impact of their instruments can undermine the broader role for monetary policy in supporting financial stability, government economic policy, stable employment and other central bank objectives.

Giving priority to certain investments through targeted central bank refinancing is compatible with central bank independence and current mandates. It will, however, require more coordination with regard to other aspects of credit policy (e.g. sustainable finance taxonomy, financial regulation, public development banks), and a change in central bank accountability and communication with the public. There are many institutional arrangements to ensure both the effectiveness of central bank measures and their democratic legitimacy.