Srinivas Medida, Sutton Grammar School

2. In recent decades, the objective of UK monetary policy has been to deliver price stability and, subject to that, to support the
government's economic objectives including those for growth and employment. In view of the challenges posed by climate change,
should the remit of the Bank of England be amended?

The Bank of England, nationalised in 1946, played a key role in implementing monetary policy,until the year 1997. May of 1997
changed this as the incoming Labour government established the Monetary Policy Committee (MPC) as part of the Bank of
England, delegating interest rate setting power. Presently, the government sets the inflation target that the MPC is meant to
achieve, now at 2% CPI per annum. Like the ECB, the Bank of England wants to maintain price stability, done by setting a specific
short term interest rate (amongst other measures); which influences other local currency interest rates.

CPI inflation projection based

on market interest rate
expectations, other policy
measures as announced, taken
from the Bank of England. ‘CPI
inflation was slightly below the
MPC’s 2% target in 2019 Q1. It
is projected to fall further below
the target over the first half of
the forecast period, and to a
greater extent than was
expected in February, largely
reflecting lower expected retail
energy prices.’¹

Although due to the Covid-19 pandemic, and measures implemented to contain its spread, the output of the UK economy fell by
more than 20% in the first half of 2020. The MPC expects output to remain below its potential level for some time, which means
there will be spare capacity (where the aggregate demand for goods and services is less than the economy's capacity to produce
them), tending to put downward pressure on inflation, the threats of inflation remain high as it is usually less responsive to spare
capacity when demand is weak.

Growth and employment also tie into the issue of inflation. A high rate of economic growth is often associated with a high level of
inflation as demand grows even faster and producers raise prices continually. A high level of employment, or rather, low levels of
unemployment could be further detrimental as employees can demand a higher wage, increasing inflationary pressure. To
counteract these low levels of unemployment, barriers to migration could be reduced, to make it easier for immigrants to enter the
UK to work. While this would achieve our desired effect of higher unemployment, it would probably also lead to a higher crime rate;
as people have nowhere to turn to, alongside potentially causing a ‘Brain Drain’ effect in the countries these skilled workers are
migrating from, increasing the gap between ACs and LIDCs. Observing the NAIRU (Non-Accelerating Inflation Rate of
Unemployment), the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise, can help
to gauge how much spare capacity there is in the economy, but it cannot be observed directly. People and technology supplement
economic growth, which leads to urbanisation, inequality, ageing populations and climate change, effectively a polycrisis. We have
the MPC to deal with inflation; with the boom and bust economic cycles that seem to be inexorable, but who will deal with these
issues? Generally, attempts by the government to control high inflation have brought about recessions (although it cannot all be
attributed to domestic government policy alone), so are we better off trying to deal with other issues? Put in the words of Milton
Friedman in a talk he gave in India in 1963, ‘Inflation is always and everywhere a monetary phenomenon’², so inflation can be
viewed as ever-present issue, having been a concept since the dawn of free market economics, in its Keynesian form, so should
the Bank of England deal with other extraordinary issues that we have a better chance of evading?

Arguably, the climate change issue is most important; rising temperatures that reflect rising fears are causing a butterfly effect;
devastating harvests; with rising sea levels putting countries at the risk of plunging under - in more than just the financial sense.
The cause of these issues stems from industry; the negative externalities of production involved in the production processes of
every good an individual can name is the reason why we have a crisis: our large population demands a large number of goods -
leading to a large amount of carbon dioxide being emitted, leading to increases in global temperatures. In ‘The Economics of
Welfare’, A.C. Pigou suggested that the government should tax polluters in accordance with the cost of the harm to others, yielding
the market outcome where the externality is internalised, making private and social costs the same.³ While following Pigou’s
guidance, the Bank of England could simultaneously subsidise those who generate positive externalities, to encourage production
of merit goods (like carbon capture technology and solar panels for example), equivalent to the benefit to others, creating a double
incentive to provide the socially beneficial outcome.

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Srinivas Medida, Sutton Grammar School

Here, Pigouvian Taxation for Coal Production is

shown. At the free market price, quantity xᵐ is
traded, due to the nature of goods which have a
negative externality often being overproduced in
the free market. After the introduction of a
Pigouvian Tax, t, the private marginal cost is
increased, from PMC to PMC’, PMC’ being the
actual cost to society. This increases the
equilibrium price (per tonne of coal), to decrease
the quantity exchanged to xᵒ; leading to a
decrease in the overall externality as less coal is
produced, and also meaning that the cost of the
externality is internalised; paid by the coal
producing firm. The shaded region indicates the
deadweight loss, or the loss of welfare to society.
⁴

However, this intervention can only work if it is possible to measure emissions accurately; as otherwise firms can pollute beyond
their limit and stay under the radar. It is also difficult to determine what the acceptable amount to pollute is; and if the level allowed
is too low, this could hinder economic productivity and make it more difficult for firms to be allocatively efficient, and if the level
allowed is too high, abuse of the environment will continue, leading to disaster on an even larger scale. As with many types of
intervention, there are enforcement costs, but these can be neglected in comparison to the cost to society to allow the further
destruction of our shared habitat as humans.

Alternatively, the Bank of England can choose to intervene using tradable pollution permits, which firms can sell to each other. The
Bank issues a right to each firm to pollute a certain amount. The permits are enforced in parallel with the threat of heavy fines to
ensure that businesses adhere to the limit. The crux of the matter here is that any firm which produces below their emissions limit
has the ability to sell the rest of their permitted emission capacity to other firms. Yet again, the same issues rise with pollution
permits as taxation, emissions have to be measured accurately and the level permitted has to eliminate the negative externality of
consumption. Potentially, the Bank of England could assign private property rights to deal with this issue of negative externalities of
production; polluting firms currently do not own the air, but if they did, they would be more concerned about their pollution as they
would be reducing the value of their own property by polluting. If consumers owned the property, they would not allow firms that use
dirty energy to pollute, unless they are being compensated.

Ultimately, the success of these intervention methods relies on a global commitment toward a common goal. The United Kingdom
alone cannot tackle the climate change issue, given we do not even rank in the top 10 global polluting economies, with the top 3
nations (China, the US and India) accounting for over 50% of all global emissions.⁵ These countries will be unable to reach carbon
neutrality by only reducing their domestic emissions, they will also need to offset their carbon footprint on international carbon
markets. Working alone is not the solution, international cooperation, working side by side increases the chances of success. If
incentives were laid out clearly, it would be evident that no nation can evade the externalities of climate change, as we all share the
same planet. Even if the Bank of England was put in charge, a target of zero environmental damage is neither technologically
possible at present or economically efficient.

So how can the Bank of England be expected to deal with the climate change issue?

I have come to the conclusion that the Bank of England cannot be put in charge of solving the climate change crisis, as it is simply
not the Bank’s purpose. The Bank of England, more specifically the MPC, serves the sole purpose of handling inflationary levels in
our economy. Perhaps the remit can be reformed to include more sustainable practice, but that cannot be the main focus, as
inflation remains their centre of attention.

Bibliography
1. sourced from the Bank of England website,
https://www.bankofengland.co.uk/inflation-report/2019/may-2019/prospects-for-inflation
2. Milton Friedman. 1963. Inflation Causes and Consequences. Asian Publishing House.
3. Pigou, Arthur C. 1920. The Economics of Welfare. London: Macmillan.
4. graph sourced from https://economicstudents.com/2019/09/climate-change-humanitys-biggest-externality/#_ftn7

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Srinivas Medida, Sutton Grammar School

5. statistic calculated using data from

https://climatetrade.com/which-countries-are-the-worlds-biggest-carbon-polluters/