A framework for central banks navigating political uncertainty in the transition

Central bankers face three different types of political uncertainty in their work: domestic, transnational and dynamic. The first two are caused by factors largely external to the central bank. Domestic political uncertainty is caused by an inherent feature of democratic systems: the government, and its preferences may shift with the next election, or even sooner. Beyond domestic borders, central bankers face transnational political uncertainty because they are embedded in global financial and economic systems that are impacted by the actions of governments around the world. Dynamic political uncertainty is caused by central bankers’ interactions with their political systems; for example, they might receive political support or face a backlash when analysing or acting on politically sensitive topics.

Central bankers encounter each type of political uncertainty in the context of climate change and a green transition. For instance, there may be uncertainty over how the climate priorities of present or future governments may shift through democratic change (domestic). Similarly, the possibility of political shifts on climate policy in other countries can also impact any given central bank (transnational). Central banks may further be concerned about the potential political effects of any financial risk mitigation policies they undertake on climate change, and how these might be viewed by their government or other political actors (dynamic).

Recommendations

While first cautioning against inaction, this report recommends three principles for coping with political uncertainty:

1. Central banks should not seek ostensibly settled preferences as a prerequisite for action, given that social and political preferences on any topic rarely reach consensus and are also subject to ongoing change and dynamism. They must instead remain guided by their objectives, which are themselves the product of democratic processes.
2. Coordination, both domestically and internationally, can help reduce some types of political uncertainty and deliver well-managed transitions.
3. Existing insights on how to cope with uncertainty in analytical work can be applied and extended to political forms of uncertainty, particularly in encouraging flexibility towards the future.