Does Monetary Policy Shape the Path to Carbon Neutrality?

Abstract: This paper empirically examines the interaction between monetary policy and carbon transition risk. Using an event study design, we find that the stock prices of firms with higher carbon emissions are more responsive to monetary policy shocks identified from high-frequency movements in Fed Funds futures around Federal Open Market Committee (FOMC) announcements. Cross-sectional tests reveal that this effect is driven by firms that are more capital intensive, with lower ESG ratings, with greater climate risk exposures, or without climate abatement plans. Using instrumental-variable local projections, we find that high-emission firms reduce emissions relative to low-emission firms, but slow down these efforts when monetary policy is restrictive. Taken together, our results indicate that monetary policy shapes the path to carbon neutrality irrespective of whether central banks embrace a climate target.