It is clear to everyone that decarbonization is happening far too slowly. Even the best-performing high-income countries are not reducing their emissions fast enough to meet the Paris Agreement targets – not even close. And a key reason for this is that while renewable energy is now regularly cheaper than fossil fuels, it is still not nearly as profitable. Returns on fossil fuel investments are about three times higher than returns on renewable energy, largely because fossil fuels tend to lead to monopoly power, while the renewable energy sector is highly competitive.

It is clear to everyone that decarbonization is happening far too slowly. Even the best-performing high-income countries are not reducing their emissions fast enough to meet the Paris Agreement targets – not even close. And a key reason for this is that while renewable energy is now regularly cheaper than fossil fuels, it is still not nearly as profitable. Returns on fossil fuel investments are about three times higher than returns on renewable energy, largely because fossil fuels tend to lead to monopoly power, while the renewable energy sector is highly competitive.

Commercial banks allocate capital based on profitability, not on social and environmental objectives. The result is that we get massive investments in sectors such as SUVs, fast fashion, industrial animal farming, private jets and advertising – even though we know these are environmentally harmful and need to be reduced – but we suffer critical underinvestment in areas that are clearly necessary for the ecological transition, such as public transport, agroecology or building renovations, because these tend to be less profitable.

Notably, there is currently no plan to gradually reduce investment in fossil fuels. This is a structural problem that we must confront. Waiting for capital to accelerate decarbonization in line with the Paris Agreement is a strategy doomed to failure.

Fortunately, there is a simple solution. Credit steering is the key to bringing finance into line with the goals of the green transition. Central banks have the power to direct credit in more socially and environmentally sensible ways. The idea is to limit the amount of credit that commercial banks and other financial institutions direct to destructive sectors (such as fossil fuels and SUVs) while increasing credit flows to more useful sectors (such as renewable energy and other green technologies).

Credit guidance was used on a large scale in the post-war period. This policy helped states to build their industrial capacity, expand their social systems and accelerate technological innovation in key sectors where rapid development was required. It is a central pillar of any successful industrial policy. And in the face of the ecological crisis, it is gaining renewed attention: a recent report by the Institute for Innovation and Public Purpose at University College London shows how credit guidance can be used to accelerate an effective green transition.

This approach can also be used to counter inflationary pressures. In a scenario where we need to increase public investment in necessary social projects – such as healthcare, housing and transport – credit controls can be used to reduce commercial investment elsewhere in the economy (again, particularly in harmful and unnecessary industries that we need to downsize), thus regulating aggregate demand. This is a much more sensible strategy for controlling inflation than a blanket interest rate policy, which can have devastating effects on people’s livelihoods and on socially important sectors.

At a time when fighting inflation has become the main concern of central banks, credit regulations are more important than ever. The inflation crisis that intensified after the Russian invasion of Ukraine has shown the limitations of the current tools central banks use to achieve the standard 2 percent inflation target – namely, interest rate policy and the purchase or sale of financial instruments. Conventional monetary policy is ill-equipped to counter what economist Isabella Weber calls “seller inflation.” Conventional tools have failed to identify the price of oil as an inflationary pressure point that affects the entire economy. These tools are blunt because they reduce demand in the wider economy without bothering to identify the specific goods for which demand exceeds supply. Credit regulations, along with other measures such as price controls, represent a far more precise tool for maintaining price stability.

A credit management strategy can have many other benefits. For example, it can be used to prevent debt bubbles by creating conditions that limit lending to financially unstable companies. If credit management of this kind had been in place in the United States at the turn of the century, it could have prevented the subprime mortgage crisis.

Some economists bristle at the idea of ​​central banks picking winners and losers in the market – even if this is done through democratic processes. Independence remains a core mandate of modern central banks. Nevertheless, the commitment to market neutrality must be balanced with other responsibilities. Central banks also perform a macroprudential function in maintaining market stability. Perhaps the greatest threat to stability in the 21st century is the risk of ecological collapse. Diverting financial resources from the sectors responsible for this threat is justified by the demonstrated need for “precautionary policy measures to prevent the emergence of potentially catastrophic risks”.

The illusion of central bank independence has been dissolving since the 1990s. In the wake of the European debt crisis and again during the Covid-19 pandemic, the European Central Bank, among others, launched massive quantitative easing programs that benefit investors at the expense of savers. Asset purchases on this scale blur the traditional distinction between monetary and economic policy. Central banks have evolved from institutions that were narrowly focused on maintaining price stability to institutions that act as a safety net for the entire financial system. Central banks’ mandates, however, have never been adjusted to reflect this significant shift in central bank policy.

If central banks are not as independent and impartial as they seem – if they are indeed inclined to represent the interests of some at the expense of others – then it makes sense to align them more transparently with democratically ratified social and environmental goals. The crises of the 21st century require a reassessment of the new role of central banks in an era of fiat currency and high private debt. Rediscovering the power of credit regulation is key both to fulfilling the macroprudential role of central banks and to guiding our economies away from ecological collapse and towards rapid green transition.

Of course, credit management is not a panacea. It does not prevent companies – including the big oil companies – from investing their own capital in harmful activities. It cannot replace other necessary regulations such as safety and labor standards. And it does not eliminate the need for public investment mechanisms to provide essential services that do not generate profits. But credit management gives us the opportunity to channel private capital toward the most urgent goals we need to achieve. It should be seen as a necessary complement to what John Maynard Keynes called the socialization of investment.

An industrial policy along these lines is no longer just a nice idea. It has become an existential necessity. We know that we need to reduce fossil fuel production according to a science-based timetable, while rapidly accelerating the development of renewable energy and other activities necessary for a green transition. Credit guidelines can help us achieve these goals, and any forward-looking government should take steps in this direction.