Institutions, monetary policy and climate change in peripheral countries
Wallace Marcelino Pereira
Federal University of Pará, Brazil
Douglas Alcântara Alencar
Federal University of Pará, Brazil
Monetary Policy Institute Blog #160
“Central banks play a crucial role in minimizing the effects of climate change, but their effectiveness is limited in countries with low institutional development.”
One of the greatest theoretical and practical challenges faced by humanity is the need to reconcile effective economic policies in a context of the continuous worsening of climate problems. This scenario requires a new perspective to interpret reality and propose solutions. In this blog, we aim to shed light on crucial issues by articulating three analytical approaches to address the challenges posed by the climate crisis: 1) Institutional Theory; 2) Latin American Structuralist Theory of Economic Development; and 3) Post-Keynesian Theory. In this context, the question arises: is it possible to implement effective monetary policy in peripheral countries, characterized by the presence of institutions with low levels of development? What obstacles need to be overcome to achieve this goal?
In 2024, the Nobel Prize in Economics was awarded to researchers Daron Acemoglu, Simon Johnson, and James Robinson, whose work highlights the relationship between a nation’s prosperity and its institutions. Institutional theory can generally be divided into two main branches: old institutionalism and new institutional economics. Old institutionalism dates to the work of Thorstein Veblen, especially his influential “Theory of the Leisure Class”, published in 1899. For Veblen (2007), institutions are fundamentally rooted mental habits that persist over time, often shaped and reinforced by the conservative classes in society.
New institutional economics has Douglas North as one of its main exponents. This theory assumes that markets, by themselves, are not perfect and that institutions play a crucial role in structuring society. In this context, institutions are understood as “formal and informal rules” that regulate social interaction, including laws, norms, contracts, and conventions. They are essential for reducing uncertainty and transaction costs, recognizing the limitations of economic agents’ rationality, as well as the impact of information asymmetries and opportunistic behaviors in economic transactions (North, 1990).
In the book “Why Nations Fail: The Origins of Power, Prosperity, and Poverty”, Robinson and Acemoglu (2012) argue that countries that manage to develop are those that implement an inclusive structure. This structure refers to a social organization that allows all citizens to participate in the development process, providing access to opportunities and social mobility. In contrast, countries that favor a small elite at the expense of the rest of the population face greater challenges in achieving development. In other words, countries with extractive institutions, where opportunities are restricted and the economic and social structure is designed to benefit and enrich a minority, tend to face significant difficulties in advancing on more complex economic issues.
This point leads us to the Latin American Structuralist Theory of Economic Development. According to this theory, the world economic system is divided between central and peripheral countries. Prebisch (1946) emphasized that the United States plays a central role as the main “cyclical center,” both in the Americas and globally. Thus, economic contractions in the United States have a cascading effect, sequentially affecting the rest of the world. As Latin American countries are peripheral economies, they cannot use the same mechanisms of intervention and monetary regulation available to central countries.
Furthermore, Latin American structuralist theorists argue that the historical occupation and insertion of Latin America into international trade led the region’s countries to specialize in the production of agricultural products and the extraction of commodities. This process established an unequal relationship of center and periphery in international trade, where Latin American countries became suppliers of raw materials, while central economies dominated the production of manufactured goods and value-added aggregation.
The peripheral region is characterized by a fragmented productive structure, low productivity, limited technological progress, and a limited capacity for self-financing, relying on resources from central countries. In contrast, central countries have a more complex productive structure, higher productivity, and a stronger ability to mobilize funds for investments. As a result, developing countries, especially those in Latin America, face more intense negative expectations from investors, particularly in times of economic uncertainty.
Finally, by integrating Post-Keynesian Theory with the two previously described approaches, we obtain a robust theoretical framework for analyzing the challenges of formulating monetary policies in the context of climate change. Post-Keynesian theory highlights that economic decisions made by individuals and companies are often based on uncertain expectations about the future, which can generate cycles of optimism and pessimism, directly affecting investment and economic growth.
By integrating Structuralist theory with Post-Keynesian Theory, we observe that the behavioral patterns of economic agents at the macro level also manifest at the regional level. Peripheral regions of the economic system, including developing countries in Latin America, are characterized by high uncertainty. Investor expectations are generally negative, driven by factors such as infrastructure deficiencies, low labor skills, high corruption, and weak institutional development. As a result, the preference for liquidity in these regions tends to be more pronounced, which presents a significant challenge for financing economic activities and, by extension, for financing the climate transition.
It is important to highlight that peripheral regions, in addition to having dense forests and rich biodiversity, often adopt extractivist institutional structures, which directly influence the treatment of the environment. This economic and social pattern allows activities such as illegal deforestation and predatory resource extraction to coexist with regulated practices. From the perspective of climate change, this presents a serious problem, as it generates economic uncertainties about the capacity of peripheral countries to implement and enforce laws effectively to mitigate the impacts of climate crises.
What about central banks?
Moreover, uncertainties spread throughout the financial system. While central banks can implement regulations aimed at environmental preservation and encourage macroprudential mechanisms, the positive impact of these measures tends to be limited in contexts marked by extractivist institutions. Commercial banks, for example, may not be stringent in evaluating the projects to be financed, as the immediate financial return from polluting economic activities tends to be significantly higher, while the penalties for environmental damage are often minimal.
Rochon, Kappes and Vallet (2022) demonstrate that central banks can influence the profitability of green assets by adjusting collateral requirements for repurchase agreements. They can also help mitigate transition risks toward less polluting activities, support the adoption of best practices, and foster the development of climate stress tests. However, the institutional framework of central countries differs significantly from that of peripheral countries. New analytical contributions depend on integrating the institutional dimension with Post-Keynesian theory to propose measures with greater chances of success in the peripheral regions of the world.
On the other hand, peripheral countries face the need to generate foreign exchange to meet their international commitments, promote economic growth, and make fiscal adjustments, which often makes it unfeasible to finance public investments aimed at a green economy. As exporters of commodities, whether agricultural products or minerals, these countries find themselves trapped in a dilemma. Climate change, in this context, reveals structural issues at the core of global economic organization, placing Post-Keynesian researchers at the forefront of analysis and solution formulation for these challenges.
Therefore, by integrating the three analytical approaches presented, it is possible to begin answering the raised questions. Firstly, central banks play a crucial role in minimizing the effects of climate change, but their effectiveness is limited in countries with low institutional development. Two challenges stand out: 1) regulations for green loans and financing require a new global institutional arrangement that considers the specific characteristics of peripheral countries in the economic system; 2) the capacity of central banks, both in central and peripheral countries, to maintain common basic agreements to mitigate climate change.
References
Acemoglu D, Robinson JA (2012) Why nations fail: the origins of power, prosperity, and poverty. Finance Dev-English Ed 49(1):53
North, D. (1990), Institutions, Institutional Change and Economic performance. Cambridge University Press, Cambridge.
Prebisch, R. (1946); Conferencias en: Memoria de la Primera Reunión de Técnicos sobre Problemas de Banca Central del Continente Americano, México, D.F., Banco de México.
Rochon, L. P., Kappes, S., & Vallet, G. (Eds.). (2022). Central Banking, Monetary Policy and the Environment. Edward Elgar Publishing.
Veblen, T. (2007). The theory of the leisure class. New York: Oxford University Press Inc. (Original work published 1899).
