Assessing the Dual Mandates of Sustainability-Linked Monetary Policy

Abstract

Central banks are now playing their part in promoting environmental sustainability. We incorporate a sustainability-linked monetary policy (SLMP), comprising an interest rate and a collateral constraint responding to carbon emission activity, into a two-agent New Keynesian model featuring direct lending. Our simulations find that shocks from supply and demand sides result in opposing effects on carbon emissions. In either case, the SLMP enhances social welfare and promotes environmental sustainability. We also find distributional effects on the welfare at the social optimum: In the presence of both demand and supply shocks, the entrepreneurs gain when a sustainability-linked interest rate is implemented, whereas the savers gain when a sustainability-linked collateral constraint is implemented.

Keywords: Sustainability, Monetary policy, New Keynesian model, Environmental policy, Central bank, Green finance

JEL Classification: E32, E50, Q58